RBI’s Interim Dividend to the Government

RBI

Relevancy

  • G.S. Paper 3 (Economic development, RBI )

Why in news?

  • The RBI recently approved an interim dividend (surplus transfer) payout of Rs 28,000 crore to the government.

How does the RBI generate surplus?

  • Income– A central bank’s income comes largely from the returns it earns on its foreign currency assets.
  • This could be in the form of bonds and treasury bills of other central banks or top-rated securities, deposits with other central banks.
  • Other sources include the –
  1. interest it earns on its holdings of local rupee-denominated government bonds or securities
  2. management commission on handling the borrowings of state governments and the central government
  • The RBI buys these financial assets against its –
  1. fixed liabilities such as currency held by the public
  2. deposits issued to commercial banks
  • Expenditure– A central bank’s expenditure is mainly on the printing of currency notes.
  • Other components include the expenditures –
  1. on staff
  2. on commissions to banks for undertaking transactions on behalf of the government across the country
  • on commissions to primary dealers, including banks, for underwriting some of the borrowings
  • Surplus– Generally, the central bank’s total expenditure is only about a seventh of its total net interest income.
  • This implies that it certainly generates a large surplus out of the excess of income over expenditure.

What is an interim dividend?

  • The surplus transfer is generally done in early August, after the completion of the bank’s July-June accounting year.
  • The RBI had thus already transferred Rs 40,000 crore to the government in August 2018.
  • So the current one is an interim transfer, in addition to the usual one.
  • With this, the government will get a total of Rs 68,000 crore from the central bank in the current fiscal.

Why is it transferred to the government?

  • The central bank transfers its surplus to the government under the provisions of Section 47 of the Reserve Bank of India Act, 1934.
  • The Government of India is the sole owner of India’s central bank, the RBI.
  • So the government can make a legitimate claim to this surplus.
  • Also, by virtue of its role as the manager of the country’s currency, the RBI generates more surplus than the entire public sector put together.
  • So this surplus, in effect, belongs entirely to the country’s citizens.
  • Given this, the RBI pays the remaining surplus after setting aside what is needed to be retained as equity capital to maintain its creditworthiness.

Is giving extra dividends a problem?

  • Much of the surplus that the RBI generates comes from the interest on government assets, or from the capital gains through other market participants.
  • When this is paid to the government as dividend, the RBI is actually putting back into the system the money it has made from it.
  • Logically, there is no additional money-printing or reserve-creation involved.
  • But when the RBI pays an additional dividend to the government, it has to create additional permanent reserves i.e. it has to print money.
  • Instead, to compensate for the special dividend, the RBI would have to withdraw an equivalent amount of money from the public.
  • The RBI does this by selling government bonds in its portfolio.
  • Besides, all central banks worry that large payouts could limit their ability to create buffers to make up for the impact of a crisis.

What does surplus transfer say about government finances?

  • This is the second year running that the RBI has paid an interim dividend to the government.
  • Last year, the RBI paid out an interim dividend of Rs 10,000 crore.
  • Notably, during periods of high growth as seen during the last decade, the government does not make demands on RBI’s surplus.
  • But the government has asked for an interim surplus for the financial year 2018-19 as well as the amount retained by the RBI from surpluses of the previous two years.
  • So surplus transfer from the RBI does indicate that the government finances are under pressure.
  • The current transfer is expected to help keep the fiscal deficit at the projected 3.4% of GDP for 2018-19.

How is it elsewhere?

  • Almost all central banks, the US Federal Reserve, Bank of England, Reserve Bank of Australia and Germany’s Bundesbank are owned by their respective governments.
  • They have to transfer their surplus or profits to the Treasury, or the equivalent of India’s Finance Ministry.
  • The UK has a formal Memorandum of Understanding on the financial relationship between the Treasury and the Bank of England.
  • It lays down a clear framework for passing on 100% of net profits to the government.
  • The US Fed too, transfers all its net earnings to the Treasury.
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