With India’s GDP falling to six years low at 5%, the credence that the Indian Economy is facing slowdown is acknowledged even by the government. Though RBI has called it a cyclic slowdown and not structural, the figures have created vexation in the market. At this crucial moment, the lender of last resort ‘The Reserve Bank of India’ has decided to transfer INR 1.76 lakh crore to the Government of India. The amount is as high as 0.5% of the GDP which caught the headlines instantly. Let us explore what reserves RBI has and how this move will impact the Indian economy.
Tools at the disposal of RBI
Both domestic sources and foreign sources contribute to RBI’s income. It makes a profit by selling government securities and bonds, known as open market operations, which helps to maintain liquidity in the economy and raise money for utilization by the government. Also, RBI has its monetary policy tools like Liquidity Adjustment Facility, Repo Rate, Cash Reserve Ratio, Marginal Standing facility, etc. through which it generates profit.
Economic Capital with RBI
Economic Capital refers to the risk capital RBI is required to hold to protect our economy against any unforeseen circumstances and risks such as a fall in foreign reserve value, bond value, the lender of last resort function, etc. Below are the RBI reserve accounts:
- The excess of the purchase value and current value of foreign assets and gold with RBI is accounted for in Currency and Gold Revaluation Account (CGRA), which is highly volatile.
- Realized equity i.e. income converted into cash is transferred into a Contingency fund for handling risks.
- Asset development fund and Investment revaluation funds to meet internal capital expenditure and investments in its subsidiaries.
An account of money transfer from RBI to GOI
RBI transfers its surplus profits to its owner i.e. the government under the RBI Act of 1934, which says that after making provisions for bad and doubtful debts, expenditure such as employee cost, printing notes, and other such matters, the balance of the profits shall be paid to the government.
- Central Bank has been transferring its surplus to contingency fund up to 2012-13 making contingency fund 9-10% of total assets.
- In 2013, Y H Malegam Committee reviewed the adequacy of reserves and recommended a higher transfer of funds to the Government of India and hence the Central Bank ceased to transfer funds to the Contingency fund.
- But in 2016-17, after demonetization, due to increased expenditure of currency printing and potential risk expected, RBI followed conservatism and paid lower funds to the Government of India, as low as 50% of that paid in 2015-16.
Eyeing the Reserve Bank?
The Government of India insisted RBI transfer excess reserves with it to the government. It argued in the Economic Survey, stating that RBI’s Economic capital INR 10 trillion is too big for the INR 31 trillion balance sheet of RBI.
However, experts argued that currency and gold revaluation reserves are unrealized profits (not turned into cash) and hence government cannot claim that RBI is overcapitalized. Also, RBI follows a conservative assessment of risk and need bigger reserves to stand financially resilient.
As a result of the tug of war between RBI and the Government of India, RBI in consultation with the Government constituted a committee, headed by Former Governor Bimal Jalan, to review its economic capital framework.
What did the Bimal Jalan Panel Recommend?
- A distinction in Economic Capital: The report noted that Realized equity can be used for meeting all risks/losses but Revaluation reserves cannot be used for meeting risks or distributed as they are not realized.
- Contingency Fund: The panel recommended the Contingency Fund to be maintained within a range of 6.5% to 5.5% of RBI’s Balance Sheet for monetary risks, financial stability risks, and operational risks. It also advised against dipping in Contingency Fund to pay a dividend in the case of income shortfall. With RBI contingency fund at 6.8% of the balance sheet, RBI decided to have Contingency fund at 5.5% and transfer the rest to the government 1.3% of balance sheet i.e. INR 52,637 crores excess provisions.
- Economic Capital Framework allowed Central bank’s economic capital to be 24.5% to 20% of the balance sheet. The economic capital of the central bank accounted for 23.3% and hence RBI transferred entire net income of INR 1,23,414 surplus to Government.
- Framework Review: RBI Economic Capital Framework needs to reviewed once it is five years and an intermediate review can be made in case of significant changes in risks.
- Accounting Calendar: RBI altered its calendar year following the report advise to modify the accounting year from July-June to April- March so as to align its accounting year with that of the government.
How Government should utilize the fund?
- The government is likely to utilize this fund in the recapitalization of public sector banks to support growth by encouraging credit flow in the economy.
- To increase infrastructure investments like Bharathmala, Sagarmala which increases competitiveness by reducing bottlenecks in logistics and attract private investment.
- Rural incomes are worst hit due to low agricultural productivity, woes of the real-estate sector led to a lack of employment opportunity. Investment in rural infrastructure as Pradhan Mantri Gram Sadak Yojana, an increase in wage pay under employment guarantee schemes can help foster rural income and their consumption.
With RBI opening its vault to help the government to ride the waves of slowdown, the government should ensure that the amount is utilized in the most productive way. There are speculations that the amount would be used to achieve the fiscal deficit targets to balance the shortage of tax collection through GST. What is necessary is that the amount should be used for creating demand which could be done through expenditure in infrastructure and other labor-intensive sectors. The government has to not just increase their expenditure but make sure that banks are re-capitalized to make them capable of lending and boosting the investments.
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