Few words about the Reserve Bank's surplus to the central government

Over the past few years we have seen the government claim that the RBI has a lot of surplus money which can be used by the country on some current purposes, so the RBI should give away that money to the government as dividend.

The governor of the RBI and some economists countered the government position saying that the surplus money should not be handed over to the government because it is the national saving for the ‘rainy day’. 

In order to decide on the optimum size of a safe surplus the government set up a committee headed by former RBI Governor Bimal Jalan. The committee has recently submitted a report and the recommendations has been accepted by the RBI, and subsequent to which the RBI decided to release funds to the tune of 1.70 lakh crores to the government.

Media and the political circles are talking about this a lot. Some of which are right, some are wrong, some are obscure.

Through this article I will try to make it easy for those who do not understand the intricacies of economics.

To understand the matter, we must first understand where the difference between the balance sheet of RBI and the balance sheet of a common trading company is and why.

Balance sheet

The left side of any balance sheet comprises the liabilities and the right, the asset.

The liabilities of a commercial entity is the face-value of its issued shares, its accumulated income (and reserves) that has not yet been distributed to the shareholder, loans taken from banks or other companies, and other current liabilities.

The assets of a commercial company are all fixed and immovable assets, money deposited in the bank, other investments, and other common assets.

The balance sheet of RBI is a little different. The liabilities of the RBI are the value of the notes printed in the country (in circulation). It also has the revaluation reserve (the different between the market value and the face value of the investments held), accumulated income, and other current liabilities.

The assets of the RBI gold (in proportion to the in-circulation note-value), bonds of the Government of India, foreign government bonds, and other current assets.

How does RBI make a profit?

Now, the question is – if RBI is not a commercial company, then what does its income comprise of? RBI's income comes from investment interest and dividends and Open-Market-Operations

Open-Market-Operations are government bonds bought and sold in the open market. The RBI basically does this to control the liquidity in the banking system.

What money did the government ask for?

The government wanted a portion of the RBI's retained earnings and revaluation reserve. It was requested because the government feels that the amount of money needed for a rainy day is more than what was actually required, also that the money can be used for government purpose. But there was no law or guidance on how much savings could be considered as enough, which led to disagreements and confusion. The government therefore constitutes a committee to create a guideline on the issue. That committee recently submitted its report - 'Bimal Jalan Committee Report on Economic Capital Framework'.

What does the committee report say?

The committee's report suggests that 6.5% to 5.5% of RBI's balance sheet can be maintained as the Contingency Risk Buffer. The rest should be considered as surplus. According to this calculation, RBI has agreed to pay the said amount.

Is this the first time any government is asking for this money?

Not at all. When Manmohan Singh was the Prime Minister, the then RBI Governor Y V Reddy was requested to release the surplus to fulfil the government's debt waiver promises, and that was done (though its magnitude was not as big as this time).

Can this money be available every year?

Sure, but the amount may fluctuate every year.

What will the government do with this money?

With this money the government can meet the GST collection deficit. That will in turn reduce the fiscal deficit which will help to keep the inflation low. It is to be remembered that the Modi government is more interested in meeting the fiscal deficit target more than any previous government. The government can also give the money to the banks so that they can lend to new projects which will boost the economy. The government can also spend this money on infrastructure development. Infrastructure spend will also increase the income of the countrymen and eventually increase the demand of goods and services in the economy.

Conclusion

Economists claim there is a recession in the country, if that is the case then it can be considered as 'rainy day' situation, and use of 'rainy day' fund cannot be unjustified? Think about it.