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- GS 3 || Economy || Banking & Financial Sector || RBI
Why in news?
- The Reserve Bank of India (RBI) will transfer ₹99,122 crores to the government from its profit, helping the Centre keep its fiscal deficit in check amid strained public finances because of the pandemic.
- The bank also decided to maintain the contingency risk buffer at 5.5 percent.
Provisions in this regard
- The RBI, founded in 1934, operates according to the Reserve Bank of India Act of 1934. The act mandates that profits made by the central bank from its operations be sent to the Centre.
- As the manager of its finances, every year the RBI also pays a dividend to the government to help with the finances from its surplus or profit.
- Bimal Jalan committee
- The Surplus Distribution Policy of RBI that was finalized is in line with the recommendations of the Bimal Jalan committee that was formed by the RBI, in consultation with the Government, to review the extant Economic Capital Framework of the RBI.
- Committee recommended that the CRB needs to be maintained at a range of 5.5% to 6.5% of the RBI’s balance sheet.
- Guiding principle- The committee has given recommendations on the principle that the alignment of the objectives of the government and the RBI is important.
Criticism of committee
This move has been criticised by some experts as having led to the erosion of autonomy of RBI.
- Buffer against externalities- such as potential threats from financial shocks, and the need to ensure financial stability and provide confidence to the markets.
- Crucial towards autonomy- of the Reserve Bank, which can be ensured only, maintaining a larger reserve, so that it doesn’t depend on the Government in times of financial stress.
- Can create inflationary pressures- in the economy with an immediate increased government spending, if it is not done properly.
- Y H Malegam (2013)
- A technical committee of the RBI Board headed by Y H Malegam (2013), which reviewed the adequacy of reserves and surplus distribution policy, recommended a higher transfer to the government.
What could have led to a higher surplus?
- In FY21, the RBI would have earned income from a larger amount of open market operations as bond purchases by the central bank raise the amount of interest it earns.
- Larger foreign exchange reserves also add to its earnings.
- Liquidity operations conducted by the central bank also added to the earnings.
- A wider spread between the reverse repo rate and the repo rate would also be a factor in this year’s surplus.
Significance of the move
- Relief to Centre
- The higher transfer will come to the aid of government finances.
- The transfer will help the government’s finances as the country battles a furious second coronavirus wave that has seen daily infections and deaths rise to a record level.
- The restrictions clamped to break the chain of infections have also put a question mark on the country’s economic recovery.
- The RBI, by transferring surplus funds to the government, did its bid to help the government so that it can take care of the needs of the people of the country.
- The transfer of money will also encourage the RBI to look for its earnings.
- Returns earned on its foreign currency assets, which could be in the form of bonds and treasury bills of other central banks or top-rated securities, and deposits with other central banks.
- Interest on its holdings of local rupee-denominated government bonds or securities, and while lending to banks for very short tenures, such as overnight.
- Management commission on handling the borrowings of state governments and the central government.
- Printing of currency notes and on staff, besides the commission, it gives to banks for undertaking transactions on behalf of the government across the country, and to primary dealers, including banks, for underwriting some of these borrowings.
- The RBI’s balance sheet should be strong enough to support banks if there is a need to recapitalise them during a financial crisis.
- India, with one the lowest sovereign ratings, and not having a reserve currency to boot, should not think that risky actions by the government would still be as safe as advanced economies.
- The fact that emergency liquidity assistance (ELA) operations by the advanced economy (AE) central banks did not result in losses for them should not draw the central banking community into any false sense of complacency about the riskiness of such actions.
How do other central banks manage the transfer of surplus?
- The central banks in both the UK and the US decide after consultations with the government.
- But in Japan, it is the government that decides. By and large, with a few exceptions, the quantum of surplus transfer averages around 0.5% of the GDP.
- Bank recapitalisation
- It would help the government to go for bank recapitalisation in a big way given the economic slowdown when channels of credit disbursements are choked because of a lack of capital with the commercial banks.
- Stimulating the economy
- The transfer of the additional surplus from the RBI could enable the government to pursue efforts towards stimulating the economy while maintaining budget discipline.
- The additional funds would also allow the government to invest more in any fiscal stimulus package that it will want to pursue to combat the economic slowdown.
- Fiscal deficit goal
- In the event of revenue shortfalls, the government will be able to reach the fiscal deficit goal without reducing spending in key areas.
- It would provide the requisite fiscal space for the government to implement structural reforms to boost economic growth.
- The RBI Board’s decision should be applauded because it will help the government in combating the economic downturn and adhering to fiscal targets.
- It is hoped that the government will use these funds wisely.
- The RBI dividend move, on the other hand, is not a panacea. To boost potential growth, India’s economy requires long-term structural reforms.
Mains model question
- “Examine the consequences of the RBI’s recent surplus transfer to the government critically. Would it aid in the recovery of the economy, which is currently experiencing a slowdown?”