Can RBI transfer funds sans assigning assets to govt?


In all likelihood, the Reserve Bank of India’s panel, which is looking into the size of capital reserves that central bank should hold or transfer to the government, will submit its report by Monday next. And in all likelihood, the recommendations of the report are going to be a huge relief to the government, which has, during elections, promised the world to various sections of the society, having too little in its coffers.

Last week, the Committee on Capital Framework, as it is known, was almost ready to submit the report to RBI, but some difference of opinion among the panel members cropped up regarding the finalisation of the recommendations. The views are almost unanimous about the RBI’s capital reserves as a percentage of its total book is much higher than its peers in Brazil, Russia and South Africa and that it needs to release funds for developmental purposes.

It will be interesting to see how the RBI transfers a portion of its reserves to the government and would it be possible for the central bank to transfer its excess reserves without transferring a portion of its assets to the government. According to Kotak Institutional Equities, Transferring ‘reserves’ entails transferring something from the asset side too.

The asset side of the balance sheet of the RBI largely comprises foreign currency assets of about Rs 27.8 lakh crore including gold coin, bullion, and government bonds of the size of approximately Rs 6.3 lakh crore out of a total balance sheet size of Rs 36.2 lakh crore as of end-June 2018.

Here, the problem will arise on how the RBI transfers a portion of its investment in the government bonds back to the government. In that case, the government will end up owning its own bonds. The whole concept of treasury bond can take a different meaning in that case. And, that may not be feasible under the Fiscal Responsibility and Budget Management (FRBM) Act. But even if it were feasible, the government would have to cancel the bonds, which would result in lower public debt without any cash inflow to the government, or sell the bonds to raise cash.

The latter would seem, according to Kotak, like a roundabout way of deficit monetisation, which may not be possible under the FRBM Act. “We rule out the RBI selling a portion of its investments in Indian government bonds in order to give cash (dividends) to the government as it is conducting OMO bond purchases currently,” it said.

In that case, the transfer of foreign currency reserves or selling foreign bonds looks like an option. But that can have other implications.

The RBI can indeed transfer a portion of its foreign currency reserves to the government. The question is what the government will do after it receives those reserves?

It can continue to sit on the reserves, which will not address its requirement for cash. Or, it can sell the foreign currency assets received from the RBI but that will result in lower foreign currency reserves of India. Now, if the RBI sells a portion of its investments in foreign government bonds and gold to give the cash to the government in the form of dividends, that will have the same impact -- a commensurate decline in the RBI’s foreign currency reserves.

The RBI can exercise the third option. Borrowing or printing currency to fund the government’s deficit. But that is not feasible. The FRBM Act of 2003 does not permit the central bank to raise its liabilities or issue notes in order to transfer more money to the government. It can issue new currency to back purchases of foreign currency assets only.

Nonetheless, the RBI has been doing strange things in the past. It has been conducting large-scale purchases of government bonds from the secondary market through its open market operations (OMOs) which is helping in terms of lower yields on the government securities. RBI’s OMOs create additional demand for government bonds as markets look for more trading opportunities. The government gets richer as investors up lending to the government in these times.

The RBI has already been transferring a bulk of its income to the government. RBI transfers its surplus profits to the government under Section 47 of the RBI Act of 1934, which says that after making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation funds and other such matters, the balance of the profits shall be paid to the central government.

RBI has transferred about Rs 3.73 lakh crore since 2010. At present, the whole noise is for transferring about Rs 3 lakh crore form its excess reserves. The whole question is even if the central bank does that, would that be enough for the government. The expenditure of the sovereign keeps increasing year after year and is wise to make efforts to increase its own revenues than depending on the contingency fund as a matter of habit.

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