Explained: 5 things about RBI dividend transfer to government touching decadal low

Reserve Bank of India

The Reserve Bank of India (RBI) on Friday decided to transfer its FY22 surplus of Rs 30,307 crore to the government, the lowest dividend in 10 years. The amount is down by 69 percent from the Rs 99,126 crore given the year earlier.

The dividend transfer of Rs 30,307 crore is much below the government’s budgetary expectation of Rs 73,948 crore from RBI and PSU banks. Thus, it has created a shortfall of around Rs 4 3,641 crore, compared to the budgeted numbers.

Here are the five things you need to know about the sudden fall in the number of dividends from the apex bank.

Why lower dividends?

Economists say that the RBI has paid substantial interest income to commercial banks for the reverse repo operations conducted during the financial year for liquidity management, as banks have parked their surplus funds with the RBI. “The surplus liquidity in the system was being invested in the daily and term reverse repo auctions. This meant a cost to the RBI of 3.35-3.99 percent. This lowered the net interest receipts of the RBI,” said Dipanwita Mazumdar, Economist, Bank of Baroda.

Alongside, low forex reserves too might have significantly contributed to the lower dividend, according to economists. At the end of December 2021, the foreign exchange reserves cover of imports (on balance of payments basis) declined to 13.1 months from 14.6 months at end of September 2021.

“Forex reserves are a bit down due to strong selling to protect the rupee. RBI has a buffer of forex reserves to import 9-10 months now. RBI is possibly extra cautious at a time when uncertainty is very high due to the ongoing geopolitical tussle between Russia and Ukraine, and high global inflationary trends,” said Sankhanath Bandyopadhyay, economist, Infomerics Ratings.

To this, Gaura Sen Gupta, Economist, IDFC First Bank, further added, “The lower dividend is likely due to losses on RBI holdings of rupee securities as G-Sec yields have risen. Another possible factor responsible for the lower profits would be provisions made to the contingency fund.”

How RBI calculates the dividend transfer

There has been a difference of opinion on the amount of surplus the RBI should pay to the Government. Over the last decade or more, the Government had sought higher payouts saying the RBI was maintaining reserves or capital buffers that were much higher than many other global central bank buffers.

“The amount of surplus that the RBI must transfer to the Centre is determined based on two factors -- realised equity and economic capital,” added Bandyopadhyay.

As per many economists, the surplus can be simply understood as a residual of the income earned and expenditure component of the RBI’s balance sheet. This is mandatorily transferred to the government.

The RBI’s revaluation loss/gains on foreign currency assets is accounted for in the currency and gold revaluation account (CGRA). The CGRA provides a buffer against exchange rate/gold price fluctuations. If CGRA is insufficient, it is replenished from the contingency fund,” added Sen Gupta.

The RBI has to follow the norms of the Bimal Jalan Committee recommendations. The Jalan panel had suggested a lower 5.5 percent level for the contingency fund (as against the upper end of 6.5 percent). This is the lowest level that the RBI has maintained thus far under the fund. This lowers the RBI’s flexibility to maneuver in the future. As per the committee, the contingency fund is for “the country’s savings for a ‘rainy day’ (a financial stability crisis), which has been consciously maintained with the RBI in view of its role as Lender of Last Resort (LoLR)”.

In 2019, the RBI had agreed to keep the contingency fund at 5.5 percent and transfer the excess to the government.

Possible impact on government finances

The pressure on government finances will be visible in lower-than-expected non-tax receipts, according to economists. Budget 2023 had estimated Rs 73,948 crore as dividend from RBI and public service banks (PSBs). Of this, the government has received only Rs 30,307 crore from RBI, implying an overall gap of Rs 43,641 crore in non-tax receipts. Last year, the government revised its target for FY22 to Rs 1 lakh crore, from the budgeted Rs 53,511 crore, and the higher income of RBI had led to a surplus dividend of Rs 99,122 crore.

“The critical factor will be the performance of PSBs for the year and the dividend that is paid to the government,” said Mazumdar.

The dividend from the RBI is lower than budgeted and this is likely to add to fiscal slippage risks. “Overall, we estimate the center’s fiscal deficit to GDP at 6.7 percent v/s target level of 6.4 percent, assuming no cuts in expenditure are made,” said Sen Gupta.

Impact on the overall banking system

The impact on the banking system is likely to be indirect. Economists say that the expectation of fiscal slippage in FY23 is led by expenditure exceeding Budget estimates (led by higher subsidy expenditure for food and fertiliser).

“In case there is no cut in other expenditure heads, the higher government expenditure would add to the banking system liquidity,” said Sen Gupta.

Lower dividend may also affect G-sec yields. “Higher borrowing because of receipt shortfall and growing expenditure will create upward pressure on G-sec yields amid an environment where RBI is looking to tighten policy,” said Sarbartho Mukherjee, Economist, Mahindra Group.

Probable way out for the government

Economists believe the government would need to look for better earnings from its other sources, as requested the RBI to raise the level of dividend pay-outs can hardly be the way out.

“The situation is volatile, so the RBI is conscious now. Instead of relying on RBI dividend, the government should ideally focus on other non-tax payments and explore other income options,” added Bandyopadhyay.

According to the economists, the government should never ask for higher dividends from its own central bank as the RBI is indirectly helping to finance the deficit with lower bond yields through open market operations. So, if the RBI gives higher dividends to the government, the apex bank will be compromising the target of achieving price stability.