What Constitutes 'Surplus': Government vs RBI on Assessment of Risk and Reserves

In August, RBI paid out a INR50,000cr dividend to the Centre; Government saw this as an inadequate amount, and requested for a much higher pay-out (allegedly ranging from INR1 lakh - INR 3.6 lakh crore, a 2.0x-7.2x higher ask - later denied). However, the question of how much 'surplus' the RBI should retain has become a bone of contention.

 

While the INR50,000cr implies a year over year uptick from INR30,659cr last year (and in-line with the year prior - 2016-17 was an exception due to demonetisation), its perceived inadequacy is what lead to a bone of contention between the Centre and the RBI. 

 

The RBI earns interest income (from its investments in financial assets) and incurs expenses such as printing costs, agency charges (fees paid out for conducting sovereign transactions etc.). The most significant expense it incurs constitutes various 'provisions' it holds. 

 

These provisions are capitalised on RBI's balance sheet as a 'surplus' reserve which is hence tapped on an ad-hoc basis.  

 

The dividend going to the government is paid-out after accounting for this 'surplus'. 

 

[Listen in from 14:20 onwards to learn more on RBI's "Surplus" and what it implies]

 

The Central Bank maintains provisions or 'surplus' to hedge market risk, operational risk, credit risk and contingency risk.

 

The 'surplus' is tapped on and off by the RBI to stabilise macroeconomic stresses such as increasing Crude oil prices, depreciating Rupee, conducting OMOs etc. In that context, they can take an element of subjectivity. The government argues that RBI's current 'surplus' is tainted with heightened conservativeness and as such impedes the use of funds for more productive economic activities.

 

The Government believes that the RBI is excessively capitalized and should hand over its additional share of 'surplus' for more efficient use.

 

Given a heightened level of inherent subjectivity surrounding the estimation of contingencies and risks, the right level of reserves is near impossible to financially engineer with precision. 

 

Consequently, it is easy to see that there are multiple lines of argument without a clear-cut “right’ answer. 

 

As per the government, RBI is excessively capitalized and should rather pay out more via dividends to the Central government which could be jointly deployed for more productive endeavors. 

 

On the other hand, RBI wants to maintain complete independence in deciding what constitutes 'surplus' and what constitutes adequate level of capitalization while maintaining its credit worthiness and preserving a suitable risk-profile.

 

RBI’s reserve stands at close to 27% of its assets, meaningfully ahead of other Central Banks around the world which average close to a 13%-14% range, suggesting room for an uptick in dividend distribution.

 

This is a widely articulated argument from the Centre’s perspective. As such, it paints an optically conservative picture on RBI’s assessment of risk and reserves. The Government appears to be of the view that it will be more prudent to disperse more cash to its budget which could be used to recapitalize PSU banks and subsequently expand their loan books. 

 

However, one might argue that comparing India to other countries such as UK, US, Singapore, Argentina etc is not a like-for-like comparison given unique risks and challenges which are specific to India and as such a comparison with other Central Bank's is an over simplification given widely differing macroeconomic and risk profiles.  

 

RBI board meeting on November 19th could potentially be centered around the issue of 'Surplus' retention and RBI’s Staggered Surplus Distribution Policy (SSDP) dividend pay-out policy.

 

Following the recent tussle around never-ever-used-before Section 7 of the RBI Act and the most recent ask for higher dividend pay-out as discussed above, the upcoming RBI board meeting could be quite meaningful. 

 

Under the current set-up, RBI uses a Staggered Surplus Distribution Policy (SSDP) framework for dividend pay-out which factors in the political and economic landscape in which it operates, in conjunction with the level of risk exposure. 

 

As government appears to be bridging the gap between monetary and fiscal policies, the role of RBI is undeniably at the core. Consequently, RBI’s board meeting could well be one of the most pivotal ones in recent times.   

 

(We are now on your favourite messaging app – WhatsApp. We highly recommend you SUBSCRIBE to start receiving your Fresh, Homegrown and Handpicked News Feed.)