Bigger RBI dividend, smaller fiscal comfort zone

India has to balance providing greater-than-expected support, due to the ongoing crisis and expected lower rainfall, with maintaining a sustainable budget

The RBI has approved the largest-ever dividend (yet slightly short of expectations) of Rs 2.87 lakh to the government, which will cover roughly 20 per cent of the latter’s deficits — a timely transfer given that the government is supporting a larger fuel and fertiliser subsidy bill. One can evaluate the transfer from legal, monetary/fiscal policy, and political economy perspectives.

First, the RBI makes profits from interest income out of its domestic and foreign investments in various bonds, as well as by selling the dollar at a higher rate, mostly because it sells the dollar to defend the rupee when the former appreciates. This means that when the rupee is falling, an activist central bank generates dividends to the government — a unique cushion many emerging-market economies, enjoy. As comforting as this might be, in a political economy as complex as India’s, it cannot dictate why the RBI needs to be aggressive in defending the rupee to help the fiscal position.

Second, the RBI pays dividends to the government under the RBI Act, 1934 (Section 47) after setting aside a minimum contingency risk buffer (CBR) in accordance with the Bimal Jalan committee recommendation — in fact, in a more conservative way. The RBI upped the maximum contingency buffer from 6.5 per cent to 7.5 per cent (of its asset position) a year ago, set aside 7.5 per cent CBR last year, and continued doing so this year. The reserve ratio is also on the higher side. Hence, it is not as if the RBI is paying the government by stretching its buffers too thin.

Then what is the problem? First, reliability and volatility. Unlike taxes, the RBI’s profits could be way more volatile than we imagine. In years to come, when the RBI decides to float the rupee more freely, the profits from selling dollars or other foreign exchange interventions will progressively contribute less to its income. The bond yields are volatile and will impart that volatility to the RBI’s interest income, too.

An active monetary policy that injects significant liquidity into the market or deploys QE-type strategies by buying government bonds needs to keep aside a larger risk buffer to support the expanded balance sheet, reducing the surplus/dividend that can be transferred to the government. The RBI injected Rs 10 lakh crore worth of liquidity this year, which expanded its balance sheet by 20 per cent, requiring a larger risk buffer. In economically challenging times, when the bank is expanding its balance sheet, the government is also likely to run an expansive fiscal programme; a cut to RBI dividends at that time hurts.

Second is the perception problem. If institutional investors perceive the RBI-government nexus as defined by the dividend mathematics, it risks running with assumptions about the central bank’s independence being compromised. The US experience — when Donald Trump attempted to control the Fed — tell us that this can significantly alter the currency’s valuation and damage the flow of foreign investment into the country’s debt and equity markets. India and other emerging economies have far less room for manoeuvre than a hegemon like the US. In other words, the fiscal nexus between the RBI and the government can create a balance of payments situation for the central bank, making it difficult for it to accumulate foreign exchange reserves in the first place. Lastly, it can lead to a fiscal profligacy problem if governments rely on RBI dividends even during good economic years.

Does India have a fiscal problem? In some respects, yes. At 85 per cent, the combined debt of the Centre and states is higher than that of many Asian peers. The RBI’s ownership of government bonds is rising, a growing share of government spending is going to debt interest payments, there is underspending on key schemes like the Jal Jeevan Mission to meet fiscal-deficit targets, and expensive promises are made during state elections. In some ways, India has to balance providing greater-than-expected support, due to the ongoing crisis and expected lower rainfall, with maintaining a sustainable budget. Either way, the RBI dividends will help.

The writer is chief economist, Muthoot FinCorp Ltd