Will The Reserve Bank Gift A Higher Dividend To The Government Or Shore Up Its Buffers?

The government would normally want the RBI to be as generous as it could be, because a higher than budgeted dividend receipts from the central bank would help bump up government revenues and add to fiscal headroom. 

Das, on his part, would like to retain a higher share of the profits as a buffer with the RBI, given the heightened risks of capital flight and volatility in markets coming from developed countries – risks that the governor has repeatedly flagged in recent times.

Can the RBI governor do both – recommend a bumper dividend payout for the government, while setting aside enough money to cushion the central bank against any unexpected adversities?

A final decision will be made at the RBI's central board when it meets to approve the books of accounts and the Annual Report of the central bank.

Decoding RBI’s Earnings

Unlike the banks it regulates, which are for-profit organisations, the RBI’s accounts reflect its functions as the monetary authority, fund manager of foreign exchange reserves, and the currency issuer.

The RBI thus earns from deploying the foreign exchange reserves in securities of major countries, particularly the US. It also parks reserves in deposits with other central banks and commercial banks, predominantly in the US and Europe. 

The other major source of income for the central banks is holding and transacting securities issued by the government for domestic monetary operations. It earns coupon payments and also makes capital gains or losses from trading in those securities as part of its monetary policy objectives.  

In 2022-23, the share of RBI’s foreign currency assets and gold stood at 72.3 per cent of its total assets, while domestic assets amounted to 27.7 per cent. 

Thus, when interest rates in the US and the UK rose in the aftermath of the Covid19 pandemic, RBI’s income from foreign sources surged – ₹1.52 lakh crore in 2022-23, up almost 70 per cent from 2020-21. 

In the last financial year, interest rates in the US and Europe have been at their peak. The Fed last hiked interest rates in July 2023, and the target rate for Federal funds has been steady at 5.25-5.50 per cent since then. Consequently, the RBI’s treasury income from foreign sources, too, would have risen sharply.

In a recent report, ICICI Securities PD estimated that income from foreign assets could rise to ₹2.6 lakh crore in 2023-24. 

The RBI also makes profits (or losses) when it buys or sells dollars (or euros) in the domestic market to stabilise the rupee’s exchange rate. 

The RBI’s income from domestic assets was at ₹83,300 crore in 2022-23, up 18 per cent from ₹70,500 crore in 2021-22. Its interest income from its holding of government bonds was almost flat in the previous two years. 

The RBI’s continued stance of “withdrawal of accommodation” and tighter liquidity since the middle of 2023-24 should result in a substantial increase in its income from domestic assets. 

However, a fall in domestic assets due to the maturity of securities and RBI’s limited government bond purchases through open market operations due to its monetary stance could result in it making relatively lower income.

ICICI Securities PD estimates that income from domestic sources could fall to ₹92,300 crore in 2023-24 from ₹96,500 crore in 2022-23.

In other words, ICICI Securities PD estimates the central bank’s total income in 2023-24 to be in the order of ₹3.5 lakh crore, compared to ₹2.4 lakh crore in the previous year.

So, how much of it would the RBI governor be willing to part with the government, the RBI’s owner?

Government’s Share

The RBI’s dividend payout could easily top the government’s estimates made in the interim budget for 2024-25. In the interim Budget presented in February, the government estimated that it would receive ₹1.02 lakh crore as dividends from RBI and PSU banks together. 

Analysis by ICICI Securities PD suggests that the RBI may pay a dividend of ₹1.2 lakh crore in 2023-24—the second-highest ever in the central bank’s history. The last time RBI paid more than this was in 2018-19 when there was a record dividend payout of ₹1.76 lakh crore. 

The actual dividend payment to the government will depend on the call the RBI’s central board makes regarding provisions for the year. 

It goes beyond a simple income and expenditure mix. 

The RBI’s board will approve provisions for the Contingency Fund, a specific fund meant for meeting contingencies from market risks and other operational risks, and the Asset Development Fund, which provides for investments in subsidiaries and capital expenditures. 

These risk provisions, along with the largely static Capital and Reserve Fund, are the components of the RBI’s Available Realised Equity under the Economic Capital Framework as recommended by the Bimal Jalan Committee and accepted by the RBI in 2019.

RBI records unrealised marked-to-market gains or losses in revaluation heads, which include the Currency and Gold Revaluation Account, Investment Revaluation Accounts, and Foreign Exchange Forward Contracts Valuation Account.

All these affect the Contingency Fund, and provisions are to be made accordingly by the RBI into that head.

As mentioned earlier, the RBI's Available Realised Capital is formed by the Capital Fund, Reserve Fund, Contingency Fund, and Asset Development Fund.

The Jalan committee had recommended that the Available Realised Capital must be in the 5.5-6.5 per cent range of the balance sheet size.

If the balance sheet expands, higher provisions will need to be made in the Contingency Fund to maintain the ratio of Available Realised Capital to the balance sheet size, as is likely to be the case in 2024-25.

The Available Realised Capital-to-balance sheet ratio was at 5.5 per cent between 2018-19 and 2021-2022 before it was raised to 6.0 per cent in 2022-23.

It remains to be seen if Governor Das proposes to the board to raise the Available Realised Capital to the upper end of the band, which is 6.5 per cent for 2023-24. 

The RBI is worried about high fiscal deficits in developed countries such as the US. In April, as part of his monetary policy statement, Das had warned that debt-to-GDP ratios had risen due to the pandemic, and a combination of high borrowings and high interest rates in developing countries could hurt capital inflows into emerging markets like India and induce volatility in financial markets. 

In fact, he went off the prepared statement to declare that the RBI will keep accumulating foreign exchange reserves to save for a rainy day. 

Another concern is the surge in capital flows expected due to India's inclusion in global bond indices. Over $25 billion of debt inflows could occur over the next year. Capital could come in and go out at great intensity, inducing volatility in the domestic markets. The RBI would want buffers even for this. 

The RBI often advises banks to build countercyclical buffers. It would want to practise some of the lessons it offers.

If incomes from foreign exchange assets rise, Das may recommend higher provisions so that the RBI can lower the Available Realised Capital-to-balance sheet ratio in future years if and when earnings fall. 

The RBI’s decision on its dividend transfer to the government will, therefore, be interesting. 

It will go beyond how it supports the centre’s fiscal plan and give a peep into how the RBI sees the coming years and how it fared as a fund manager in a tumultuous and yet rewarding year.

(Kalyan Ram is a Mumbai-based journalist with 30 years of experience in driving coverage of central banking and macroeconomy. Views expressed are personal)