A burdensome quasi fiscal deficit

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Published: Monday, 02nd September 2019

There has been an animated debate since August 26, 2019 on the decision of the Reserve Bank of India (RBI) to transfer its surplus under section 47 of The RBI Act, 1934. The amount is Rs. 1,75,987 crores, which amounts to around 0.8 per cent of GDP. Such a transfer is unprecedented in RBI history. There are two components of this transfer: the first component is surplus before the adjustment to excess risk provision amounting to Rs. 1,23,414 crores and the second component is amount written back from contingency reserve fund aggregating Rs. 52,637 crores.

According to the committee, the RBI should maintain CRB within the range of 6.5 per cent to 5.5 per cent of the RBI’s balance sheet comprising 5.5 to 4.5 per cent for monetary and financial stability risks, and 1 per cent for credit and operational risks.  The surplus transfer policy is now formula based and thus transparent, which is an important departure from the past. The formula based CRB will take care of the risk provisioning and the central board of RBI will decide on the level of risk provisioning. 

The surplus transfer was based on the recommendations of the ‘Expert Committee to Review the Extant Economic Capital Framework of the Reserve Bank of India’ (Chairman – Dr. Bimal Jalan). The committee was constituted on December 26, 2018, as per the decision of the RBI central board on November 19, 2018. The recommendations of the Jalan committee relating to surplus transfer was based on the size of the realised equity which is required to cover credit risk and operational risk which the committee referred to as Contingent Risk Buffer (CRB). According to the committee, the RBI should maintain CRB within the range of 6.5 per cent to 5.5 per cent of the RBI’s balance sheet comprising 5.5 to 4.5 per cent for monetary and financial stability risks, and 1 per cent for credit and operational risks. It may be noted that for the four year period 2015-2018, the CRB was in the range of 7.05 per cent and 8.4 per cent. For 2019, this stood at 5.34 per cent after writing back of excess provision of Rs. 52,637 crores. The economic capital as on June 30, 2019, stood at 23.3 per cent of the balance sheet.

The surplus transfer policy is now formula based and thus transparent, which is an important departure from the past. The formula based CRB will take care of the risk provisioning and the central board of RBI will decide on the level of risk provisioning. 

The overall surplus transfer of Rs. 1,75,987 crores in 2018-19 as against Rs. 50,000 crores in the previous year represents an increase of around 252 per cent. This is because the net income was higher with increase in gross income by 146.59 per cent and decline in expenditure by 39.72 per cent. The total income of RBI (amounting to Rs. 1,93,036 crores) comprised interest income of Rs. 1,06,837 crores and other income comprising (broadly) commissions, rent realised, profits or loss on sale of bank’s property, provisions no longer required and miscellaneous of Rs. 86,199 crores. The other income has shown a huge increase on account of provisions no longer required amounting to Rs. 52,626 crores as against Rs. 373 crores because of write back of excess risk provision from contingency fund to provisions no longer required.

The surplus transfer in coming years thus, is critically dependent on the excess risk provisioning and subsequent written back from contingency fund to income. As alluded to earlier, the Jalan committee has recommended CRB within the range of 6.5-5.5 per cent of the balance sheet and the final decision of the risk provisioning depends on the central board.

This practice of managing the budget through quasi fiscal deficit is against the basic principle of prudent fiscal management. Furthermore, it gives a negative signal to foreign investors and credit rating agencies. This development is critical as the government has proposed the issuance of sovereign bond of around US$ 10 Billion. The reduction in fiscal deficit has its impact on the financing of the same.

The transfer from contingency fund to income is essentially an accounting arrangement to increase income. Even though it is transparent and formula based, it doesn’t have the potential of true income. The true income, in RBI context, are interest income earned from domestic source and foreign sources. As evidence suggests, there are market uncertainties both domestic and global which could be a risk factor and could be much higher than the risk factor recommended by Jalan Committee. It is important, therefore, on the part of  the central board to protect the RBI balance sheet with a higher provisioning and not to support the government with a quasi fiscal deficit.

The surplus transfers to government amounting to Rs. 1,75,987 crores will be recorded as a non-tax revenue in the government account. With this additional amount, the non-tax revenue in 2019-20, will be almost double at Rs. 4,89,166 crores as compared with the previous year (Rs. 2,46,219 crores). Inter alia, the net impact of the budget will be revenue deficit and fiscal deficit will be reduced to 1.5 per cent and 2.5 per cent of GDP in 2019-20. Bonanza received from RBI by the government in academic literature is known as quasi fiscal deficit. This practice of managing the budget through quasi fiscal deficit is against the basic principle of prudent fiscal management. Furthermore, it gives a negative signal to foreign investors and credit rating agencies. This development is critical as the government has proposed the issuance of sovereign bond of around US$ 10 Billion. The reduction in fiscal deficit has its impact on the financing of the same. The government with such huge surplus transfer, may reduce the budgeted borrowing programme which will adversely affect the debt management strategy of the government. In the event, the government goes for the budgeted market borrowings, there will be a huge cash surplus maintained with the RBI making cash management and monetary management difficult. These critical issues need to be addressed.

From the foregoing, it may be concluded that surplus transfer from the RBI has implications for RBI balance sheet, government budget, financial market and above all monetary policy and debt management by RBI. Since, surplus transfer in essence, is a quasi fiscal deficit by the government, care should be taken not to swell this by accounting arrangement irrespective of the transparency in the operation. End of the day, there are two balance sheets, even if the government is the owner of the RBI. It is prudent always to protect RBI balance sheet.

(Pattnaik is a former Central banker and a faculty member at SPJIMR)