Fault lines in RBI’s surplus transfer to govt

The RBI’s account for 2020-21 released on May 27 came a week after the Central Bank announced the amount of surplus it would transfer to the Central Government. After the 589th meet of the central board of the RBI, the following announcement came in: “The Board also approved the transfer of Rs.99,122 crore as surplus to the Central Government for the accounting period of nine months ended March 31, 2021 (July 2020-March 2021), while deciding to maintain the Contingency Risk Buffer at 5.50%.” The transfer, as expected, made it to the headlines; the contingency risk buffer, or CRB, is usually less discussed and less understood.

There are many ways in which the accounts and the transfer can be analysed, the commonest of which is to compare it to the previous year. But the RBI is not any other corporate entity; its mission is not to deliver profits to its shareholders but to maintain financial stability, to keep inflation under check while keeping in mind the objective of growth. The RBI numbers and y-o-y “performance” can be studied under this meta-picture.

The higher transfer is an attempt to lower the fiscal deficit, reduce borrowing cost and cushion the weak cash management 

The accounts show the RBI’s income for the year (at Rs.1,33,272.75 crore) was down 10.96 per cent, the expenditure (at Rs. 34,146.75 crore) declined steeply 63.10 per cent, giving the surplus amount that was transferred to the Centre. The surplus transfer in 2020-21 thus, represents an increase of 73.51 per cent, up from the Rs.57,127. 53 crore reported in the previous year.

The decline in income as mentioned above was mainly on account of decline in interest income (at Rs. 69,057.9 crore) by 58.3 per cent. This came on account of contractions in interest income on holdings of domestic rupee securities (14.9 per cent), net interest on liquidity adjustment facility (LAF) operation (37.6 per cent) and foreign securities (30.2 per cent).  The decline in expenditure was primarily due to lower provisions (transfers to the contingency fund) at Rs.20,710.12 crore than that of Rs.73,615.0 crore in the previous year. In the RBI accounts, unlike in corporate balance sheets, provisions are meant to meet unexpected and unforeseen contingencies, including depreciation in the value of securities, risks arising out of monetary/ exchange rate policy operations and the systemic risks arising out of the central banking functions

RBI classifies income received from foreign exchange transactions as “other income” in its accounts which was higher by 68.8 per cent than that of the previous year mainly from the valuation gains in foreign exchange transactions as the US dollar depreciated against major currencies.  

With the provisions of Rs. 20,710.12 crore, the total amount in the contingency fund, or CRB, stood at Rs. 2,84,542.12 crore or 5.39 per cent of the total asset as on March 31, 2021 as against 5.38 per cent at end June 2010.

RBI as the monetary authority injected huge liquidity in the system which was around 6.9 per cent of GDP, and as a fallout of this liquidity support, RBI as debt manager was able to manage the market borrowing of the government at a weighted average cost of 5.79 per cent, which was a 17-year-low. 

In terms of numbers, this might look like a reasonably good performance in a difficult year. The RBI decided to keep the contingency risk buffer (CRB) at 5.5 per cent of the balance sheet.  A perusal of the movement of this buffer shows that a steady decline from 7.6 per cent as on end-June 2017 and 10.3 per cent as on end- June 2011. .

Since 2018-19, the surplus transfer provision and policy has followed the Bimal Jalan Committee recommendation that CRB be kept in the range of 6.5 per cent to 5.5 per cent of the RBI’s balance sheet. This was broken down to 5.5 to 4.5 per cent buffer for monetary and financial stability, and the balance 1 per cent for credit and operational risks.

The question that must be asked is should the RBI transfer more to the Central government and keep to the lower end of the buffer. In a world marked by uncertainty of the kind we have seen with the pandemic, economies can turn, overnight pressures can build and the capacity to maneuver is often limited by the strength of the balance sheet. A robust RBI balance sheet is a reflection of India’s economic standing, so any attempt to strengthen this builds for the long term and any attempt not to do so is meeting the needs of the government of today without looking at the possibility of a difficult tomorrow.

The surplus transferred to the Central government from the RBI is translated into non-tax revenue in the union budget. This results in a lower fiscal deficit; yet such a transfer is nothing but a quasi-fiscal deficit and against prudent fiscal management.  Technically speaking, central banks can increase their profits limitlessly by the power of printing money (seigniorage). Should central banks keep doing that and transfer larger surpluses to the government, unmindful of the risk of inflation and therefore the failure of the central bank to meet one of its key mandates?

Central banks can increase their profits limitlessly by the power of printing money (seigniorage). Should central banks keep doing that and transfer larger surpluses to the government, unmindful of the risk of inflation and therefore the failure of the central bank to meet one of its key mandates?

In the context of quasi fiscal operation, it is important to address RBI’s role and function as debt manager of the government and banker to the government.  During 2020-21, the RBI was entrusted to manage the gross market borrowings of the Central government to the tune of Rs. 13,70,324 crore comprising the actual gross borrowings of Rs. 12,60,324 crore and borrowing to the tune of Rs. 1.10 lakh crore under the special window for the States and Union Territories(UTs) towards GST compensation cess shortfall.

RBI as the monetary authority injected huge liquidity in the system which was around 6.9 per cent of GDP, and as a fallout of this liquidity support, RBI as debt manager was able to manage the market borrowing of the government at a weighted average cost of 5.79 per cent, which was a 17-year-low with a weighted average maturity of 14.49 years. Any liquidity support by the RBI by injection of liquidity is by printing money.

Again, the gross market borrowings for 2021-22 through dated securities are placed at Rs.12,05,500 crore, on the top of gross market borrowings of Rs.13,70,324 crore in 2020-21. Should RBI as monetary authority inject huge liquidity and RBI as debt manager overplay its role to mobilise the borrowing amount at lower cost as in 2020-21? The available data, on the contrary, reveals that the borrowing cost has gone up. For example, the cost of borrowing for a 10-year bond, which was 5.76 per cent in 2020-21 (May 15), has increased to above 6 per cent in the current fiscal so far (in the range of 6.20 per cent and 6.31 per cent, till May 21, 2021). Thus, higher surplus transfer in the disguise of a quasi-fiscal operation is an attempt to lower the fiscal deficit and reduce borrowing cost.

In the end, the fault lines in surplus transfer are all pervasive. Fiscal support during a pandemic is important but it should not come at the cost of fiscal sustainability.

It will not be out of place to mention the increased level of Ways and Means Advances (WMA) which the Central government avails of from the RBI (banker to government as per Section 17(5) of RBI Act 1934) to meet the temporary daily cash mismatch. The WMA limits were fixed at Rs. 1,25,000 crore for H1 of 2021 and subsequently increased to Rs. 2,00, 000 crore. For H2, the WMA limit was set at Rs. 1,25,000 crore. The Central government resorted to over draft for 63 days with a highest amount of WMA and Overdraft (OD) at Rs. 2,24,078 crore on May 3, 2020. Availing of higher WMA limits along with OD is not only a reflection of weak and inefficient cash management of the government as it is tantamount to the use of WMA as a resource to finance the deficit of the Central government. Higher surplus transfer is again an attempt to cushion the weak cash management of the government. 

In the end, the fault lines in surplus transfer are all pervasive. Fiscal support during a pandemic is important but it should not come at the cost of fiscal sustainability. The fault lines are a reminder of the famous line Shakespeare’s Julius Caesar, “The fault, dear Brutus, is not in our stars - but in ourselves.”

The writer is a former central banker and a faculty member at SPJIMR. Views are personal)