Economic impact of RBI’s record dividend to government

The record dividend paid by the Reserve Bank of India (RBI) to the Union government may not be something to celebrate because, legally, RBI is unlike any other bank.

—

The Reserve Bank of India (RBI) decided to pay a record dividend of ₹2.11 lakh crore to the Union government for 2023–24. Last year it paid ₹87,416 crore.

This is 0.64 percent of India's Gross Domestic Product (GDP) and helps the Union government reduce its budgeted fiscal deficit of 5.1 percent in 2024–25 by about 0.37 percent of the GDP, with other things remaining the same. The financial markets welcomed the news of the record dividends since it implies that the government will borrow less from the market.

The previous highest dividend was in 2018–19 when RBI declared a dividend of ₹1.76 lakh crore. The issue was contentious then too. The Union government wanted a large transfer to check its growing fiscal deficit and was putting pressure on RBI for it.

The matter was settled when the then RBI governor Shri Urijit Patel prematurely resigned in December 2018 and RBI adopted the Bimal Jalan Committee Report on the Economic Capital Framework (ECF), which defined the safe levels of reserves required to be held by RBI (5.5 percent to 6.5 percent of the balance sheet size).

Officials have argued that the current large transfer is within this framework. The Opposition has not challenged this large transfer since it came during the ongoing general elections when the attention was focused on other critical political matters.

RBI's income

How does RBI, a Central bank, generate a surplus? It is not a usual economic entity, producing normal goods and services for a profit. It gets currency printed and circulated in the economy to enable transactions to take place.

Also read: GDP data for Q3 2023–24: The mystery of a robust growth

This is a unique role in the economy. It is mandated to control inflation which is taken to be a monetary phenomenon. For this purpose, it sets interest rates in the economy to impact demand and decide on the amount of money available in the economy.

Further, it is a banker to the government, managing its accounts. It also acts to provide stability to highly volatile financial markets that are often buffeted by internal and external shocks and changes.

To perform these tasks, it acts like a financial institution that lends to banks and takes deposits from them. It is called a lender of last resort. To stabilise the money supply, banks have to hold a 'cash reserve ratio' (CRR) with RBI.

On this deposit, RBI does not pay an interest. But when banks have a surplus above the CRR, they deposit that with RBI to earn interest. When banks are short of funds, they borrow from RBI and pay interest on it. So, RBI earns a net interest income from deposits.

RBI's balance sheet

RBI also manages foreign exchange flows and holds foreign exchange reserves. When foreign exchange comes into the country, it is deposited with RBI, and corresponding rupees are released. It releases foreign exchange to those who have to make payments abroad. This leads to the withdrawal of money from circulation.

Thus, there is a net flow of foreign exchange into and out of the nation. The excess of the inflow is held as foreign exchange reserves. These reserves are largely invested abroad in different forms to earn an income. A certain amount of gold is also bought as an investment. Of late, more gold is being bought given the international uncertainty.

The value of the foreign exchange reserves fluctuates in rupee terms as the value of the rupee changes vis-à-vis the currency in which the reserves are held abroad. This results in a capital gain or loss. If the dollar was worth ₹50 when it was bought and today it is at ₹75, then a 50 percent capital gain is made and the reserves grow in rupee terms.

Similarly, on RBI's domestic holding of bonds and securities (of government and banks) as interest rates change, there is a capital gain or a loss. To take care of these fluctuations, a contingency fund is kept by the RBI.

Also read: Black economy persists with or without electoral bonds

In brief, RBI holds assets and has liabilities as reflected in its balance sheet. These will change when the dividend is paid to the Union government. What will be the economic impact?

RBI's surplus

RBI's accounts for any year are released in its annual report which presents the balance sheet for the year-end (March 31) and the income statement for the financial year.

Explanations for the various heads under these two statements are given in the Schedules. This is like what any firm does when it presents its annual accounts to its shareholders. In the case of RBI, the government is the owner and the report is sent to the Union ministry of finance.

The income statement lists the incomes (mentioned above) and expenditures. The difference between them is called the surplus. This surplus has increased over the last year due to an increase in the interest income by ₹45 thousand crore and a dramatic reduction in provisions by ₹88 thousand crore. This surplus is transferred to the Union government as a dividend.

How is this surplus/dividend shown in the balance sheet and how is it paid to the government? Unlike a usual firm, RBI's surplus does not lie in some bank which can be withdrawn and distributed to the shareholders as a dividend.

In the balance sheet, there is a category under liabilities called other liabilities. It is described in Schedule 4 and mentions the surplus payable to the Union government as ₹2,10,873.99 crore. When this surplus is transferred to the Union government, the liabilities of the banking division of RBI will decline by this amount.

Correspondingly the asset side of the banking division of RBI must also contract by this amount. The assets in the form of Gold (₹2,74,714 crore) and foreign investment (₹14,89,081 crore) constitute the foreign exchange reserves. If they are sold to pay the government, reserves will fall.

Also read: The K is Indian GDP's reality: Why deny?

What can be sold to pay the dividend has to come from the heads of domestic investment (₹13,63,369 crore) and loans and advances (₹3,75,593 crore), mentioned in Schedules 9 and 10.

Conclusion

When some of these investments and loans, and advances are liquidated, the money supply will contract. The Union government will get these funds and use them over time.

Its market borrowing will decline by this amount during the year. Further, this dividend is a transfer from RBI on which the government will not have to pay any interest.

So, the government can show a lower fiscal deficit both by showing higher income and lower revenue expenditure. We would not know if there was government pressure for this large surplus so that it could show a lower fiscal deficit in the budget.

As RBI withdraws funds from banks, they will have to reduce their lending and that will raise interest rates in the short run which will not help increase the tepid private investment.

Thus, RBI's increased surplus is due to a dramatic reduction in provisions which is not explained in the Schedules. Further, dividend to the government is a bit like deficit financing of old. This will have an economic impact not only because the amount is large but also because RBI is unlike a usual firm paying dividends to its shareholders.