Let RBI decide

The Reserve Bank of India (RBI) is reportedly studying the feasibility of a dividend policy, which will require it to transfer to the government a pre-determined portion of the surplus it earns. The policy, which is being discussed on the insistence of the government, would require amendments to the RBI Act. The matter was raised by the government’s nominees to the RBI board following differences over the dividend paid for 2016-17.

The RBI had transferred Rs 306 billion of its surplus to the government, which was less than half the Rs 659 billion it gave a year earlier. As the amount fell far short of the Budget target, the finance ministry had asked the RBI for an additional Rs 130 billion. After putting up initial resistance on grounds that the lower dividend was due to the costs associated with demonetisation and the need to provide for contingency reserves, the RBI gave in and transferred Rs 100 billion as interim dividend.

The government’s pressure on the RBI for a policy is unwarranted as the central bank has already said in its annual report for 2015-16 that it has prepared a “draft economic capital/provisioning framework to assess its risk-buffer requirements in a structured and systematic manner”. This framework will be used for determining the surplus transferable each year to the Centre. In that context, the demand for a separate policy makes little sense. The central bank transfers its surplus to the government in accordance with Section 47 (Allocation of Surplus Profits) of the RBI Act, which says that the amount will be arrived at after making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation fund. So the legal framework is already in place.

Besides, the central bank’s board, which has government nominees, should be the best judge of the amount of contingency reserve it needs. The RBI also has the wisdom of several committees to guide it. For example, a 2013 committee headed by Y H Malegam had questioned the adequacy of reserves held by the RBI. It had recommended that each year the RBI transfer 15 per cent of the original cost of fixed assets to the prevailing asset development reserve. The committee had also recommended that the contingency reserves held by the RBI be built up.

Also, it’s not that the RBI has been routinely denying transfer of surplus to the government. The RBI did not transfer any funds to its reserves in the three previous financial years, and transferred the entire amount to the government. So one year of lower dividend should not disappoint the government so much. The bigger point is the government’s belief that the RBI’s reserves are far in excess of prudential requirements. Chief Economic Advisor Arvind Subramanian has suggested part of the RBI’s capital be used for other purposes such as recapitalisation of banks.

In the Economic Survey of 2016-17, Mr Subramanian had said that the RBI holds excess capital when compared to other global central banks and argued that it would be more productive to deploy the capital elsewhere. But former RBI Governor Raghuram Rajan had opposed this on the grounds that if the RBI were to reduce its assets, its ability to absorb government borrowings by buying bonds would stand reduced. The matter is complex and needs to be debated in detail. In the meanwhile, it would be better if the current practice of extensive pre-Budget discussions between the government and the RBI on the payout by the latter continued. Central banks and the governments in both the UK and the US do precisely that. A separate policy will only create dissonance.

Cash management bills (CMBs) are short-term money market instruments