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Friday, July 20, 2018

Understanding RBI-govt surplus transfer: Why, how, how much

The central bank has said it will transfer Rs 30,659 crore to the govt in 2016-17, half of the Rs 65,876 crore it gave in 2015-16. Who decides the amount? How is it important? The Indian Express explains.

Written by Shaji Vikraman | Updated: August 14, 2017 9:17:22 am
Non-performing assets, bad loans, FY17 bad loans, Insolvency and Bankruptcy Code, Reserve Bank of India, Finance ministry data on bad loans The RBI isn’t a commercial organisation like the banks or other companies that are owned or controlled by the government — it does not, as such, pay a “dividend” to the owner out of the profits it generates.

On Thursday, the Reserve Bank of India (RBI) said it would transfer Rs 30,659 crore to the government as surplus for 2016-17, less than half of what it had given the preceding year — leaving analysts and economists guessing the reasons for the lower payout. Unlike the banks it regulates, RBI isn’t a company or an organisation that announces a dividend. So how is the transfer of its surplus worked out?

How does a central bank like the Reserve Bank of India (RBI) make profits?

The RBI is a “full service” central bank — not only is it mandated to keep inflation or prices in check, it is also supposed to manage the borrowings of the Government of India and of state governments; supervise or regulate banks and non-banking finance companies; and manage the currency and payment systems. While carrying out these functions or operations, it makes profits. Typically, the central bank’s income comes from the returns it earns on its foreign currency assets — which could be in the form of bonds and treasury bills of other central banks or top-rated securities, and deposits with other central banks. It also earns interest on its holdings of local rupee-denominated government bonds or securities, and while lending to banks for very short tenures, such as overnight. It claims a management commission on handling the borrowings of state governments and the central government. Its expenditure is mainly on the printing of currency notes and on staff, besides the commission it gives to banks for undertaking transactions on behalf of the government across the country, and to primary dealers, including banks, for underwriting some of these borrowings.

What is the nature of the arrangement between the government and RBI on the transfer of surplus or profits?

The RBI isn’t a commercial organisation like the banks or other companies that are owned or controlled by the government — it does not, as such, pay a “dividend” to the owner out of the profits it generates. Although RBI was promoted as a private shareholders’ bank in 1935 with a paid up capital of Rs 5 crore, the government nationalised it in January 1949, making the sovereign its “owner”. What the central bank does, therefore, is transfer the “surplus” — that is, the excess of income over expenditure — to the government, in accordance with Section 47 (Allocation of Surplus Profits) of the Reserve Bank of India Act, 1934: “After making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation fund [and for all other matters for which] provision is to be made by or under this Act or which are usually provided for by bankers, the balance, of the profits shall be paid to the Central Government.” The Central Board of the RBI does this in early August, after the July-June accounting year is over.

Read | In tussle over size of surplus, differing views of prudence

Does the RBI pay tax on these earnings or profits?

No. Its statute provides exemption from paying income-tax or any other tax, including wealth tax. Section 48 (Exemption of Bank from income-tax and super-tax) of the RBI Act, 1934, says: “Notwithstanding anything contained in [the Income-Tax Act, 1961], or any other enactment for the time being in force relating to income-tax or super-tax, the Bank shall not be liable to pay income-tax or super-tax on any of its income, profits or gains.”

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Why is the transfer of surplus significant to the government?

The quantum of surplus transferred over the past few years has been large. In 2015-16, the RBI passed on Rs 65,876 crore, which formed a sizeable chunk of the revenue which the government earns under the head of ‘non-tax’, which is mainly dividends. This was much more than the surplus generated by banks and other companies owned by the government. The quantum of RBI transfers has in fact, been rising progressively, and has helped the government narrow its deficit or borrowings. That is why the halving of the 2015-16 surplus this year — from Rs 66,000 crore to Rs 31,000 crore — has raised concern in the markets over the possible impact on the government.

But why was the surplus lower this time?

A clear picture will emerge later this month when the RBI releases its annual report. For now, the reasons that are being given are: the possibly lower returns on the RBI’s overseas investments due to low global interest rates (even though it was low at 1.29% in 2015-16, too); and increased costs on account of liquidity management (the interest it has to pay to banks when there is excess liquidity and it conducts ‘reverse repo auctions’), especially after the demonetisation exercise of November 2016. The surplus available will also be lower if the RBI has made provisions to set aside some funds for specific purposes.

How does the government build this surplus into its Budget early in the year?

Well before the annual Budget is unveiled (the exercise was brought forward to February 1 this year), senior RBI and government officials discuss the likely amount which could be transferred. Typically, the government pitches for a higher share of the surplus while the central bank sometimes prefers to set aside funds for contigencies. Based on these talks, and calculations such as likely income and earnings, an indicative figure is given to the government, which it puts under the head ‘non-tax revenue’ in the receipts budget.

Is there an explicit policy on the distribution of surplus?

No. But a Technical Committee of the RBI Board headed by Y H Malegam, which reviewed the adequacy of reserves and a surplus distribution policy, recommended, in 2013, a higher transfer to the government. Earlier, the RBI transferred part of the surplus to the Contigency Fund, to meet unexpected and unforeseen contigencies, and to the Asset Development Fund, to meet internal capital expenditure and investments in its subsidiaries in keeping with the recommendation of a committee to build contigency reserves of 12% of its balance sheet. But after the Malegam committee made its recommendation, in 2013-14, the RBI’s transfer of surplus to the government as a percentage of gross income (less expenditure) shot up to 99.99% from 53.40% in 2012-13.

Do the RBI and the government agree on this?

The government has held the view that going by global benchmarks, the RBI’s reserves are far in excess of prudential requirements. Chief Economic Advisor Arvind Subramanian has suggested that these funds be utilised to provide capital to government-owned banks. The central bank, on its part, prefers to be more cautious and build its reserves — keeping in mind potential threats from financial shocks, and the need to ensure financial stability and provide confidence to the markets. From the central bank’s perspective, bigger reserves on its balance sheet is crucial to maintaining its autonomy.

How do other central banks manage the transfer of surplus?

Like in India, central banks in both the UK and US decide after consultations with the government. But in Japan, it is the government that decides. By and large, with a few exceptions, the quantum of surplus transfer averages around 0.5% of the GDP.

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