Why is RBI’s dividend a godsend for the Government?

Last week, the RBI announced a dividend payout of close to ₹ 1 Trillion for the Indian Government! But how, why & so what? If you aren’t aware, here’s help.

The Reserve Bank of India on May 21 announced that it would transfer a surplus of Rs 99,122 Crore to the Government of India for the period of 1st July 2020 to 31st March 2021. Why for nine months (and not twelve months), you ask? Well, this year, the RBI has tweaked its accounting year from July-June to the standard practice of April-March. That’s precisely the reason for only three quarters’ dividends. 

Anyway, to put it into perspective, even this nine-month dividend payout is 73.5% higher than the entire last year’s dividend and almost double what the Government was expecting to receive this year! 

As evident, there’re mixed opinions this time around. While it’s all over the news, people aren’t much aware. So, we’ll explain this issue in a lucid manner.

At the outset, let’s understand why RBI transfers surplus to the Government in the first place.

Why does the RBI transfer its surplus to the Government?

Let’s go back to the pages of history. The RBI was founded in 1934 under the Reserve Bank of India Act (1934). And was initially private-owned. It was only in 1949 that the bank was nationalized, and since then, it is fully owned by the Government of India.

Being the manager of Government finances, every year, the RBI pays dividends to its sole-owner (GOI) out of its surplus profits. That’s simply like a company paying dividends to its shareholders.

However, the payout ain’t so easy-peasy! Normally, you would expect that the RBI first allows for provisions, contingency risk buffer, depreciation, salary and other expenses, and only then, transfers the left-out amount (surplus) to the Government. But, in fact, it's the other way round. Based on the Government's demand, the RBI decides how much dividend it plans to pay, and accordingly, it can (literally) chalk out its profits! But how, you ask? Well...

How did the RBI amass such a hefty sum?

If the RBI wants to turn a profit, it has its sources. It has the superpower of minting money! It can print rupees and fund government bonds for the centre and the states. Note that the cost of printing is next to nothing. So, whatever interest it receives on those bonds is for it to keep. Meaning, the entire incremental bond portfolio becomes its income.

And as its holding of these government bills increased by about Rs 3 Trillion, can you imagine how much the RBI would have made out of the arrangement? Nah, you can’t!

But that’s not all. The RBI can tweak its forex policy mechanism to turn a profit as well. And how, you ask?

Well, if you’re aware, the RBI had accumulated huge forex reserves over the past year. At one point, we even surpassed Russia to become the fourth largest forex holder in the world. All in all, our forex reserves rose by a whopping Rs 6.5 Trillion in just one year! And these reserves, when invested in foreign bonds and deposits, can earn interest of up to 2.25%. So, that’s another source.

Besides, the RBI has resorted to one infamous gimmick of turning a profit! With huge forex reserves in its wallet, what it did is, basically, sell dollars spot & buy dollars forward. When you sell dollars now (spot), the dollar becomes weak, and then, you buy it later (forward) with lesser rupees, thus earning the spread as your profit.

If you look at the figures, you’ll notice that both the dollars purchased and sold this year have more than doubled in comparison to the last year. Also, without any other significant influence, this activity has gained traction over the previous three months. So, it’s only natural to infer that the RBI was doing this to make a profit and meet the higher demand for dividends.

So, now you know how the RBI accumulated such a thick sum of money. Anyway, the essential question is...

Why does the Government badly need this money?

These are fighting times! The second wave of the virus is plaguing the nation. Whether you look at hospital beds or oxygen cylinders, or vaccines, we’re bleeding everywhere! To add to our misery, cases of black, white and yellow fungus are propping up. Besides, we’re already staring at subsequent waves of the coronavirus!

Meaning, the healthcare infrastructure is already at its brink. A little more mismanagement and the situation could be totally out of hand! While on the economic front, you can’t afford the nation to remain shut for longer. It could push many, who are already on the verge of being broke (due to large-scale unemployment), to dire straits! Meanwhile, experts already predict a grim outlook for the economy.

So, the least the Government can do is loosen its purse strings. It has to build up its healthcare infrastructure, fund hospitals, construct oxygen plants, ramp up the supply of vaccines and do numerous sorts of things. It has to boost consumer demand and trigger the economy. It is also facing increasing pressure of funding a cash transfer scheme to keep the poor from hitting the streets.

But there is an inherent problem. The Government is struggling to keep up with its finances! With lockdowns in most parts of the country and lackluster consumer demand, the indirect tax revenue collection will most likely be scarce! Besides, as the commodity prices are rising through the roof, companies’ profit margins are most likely to be narrowed, and hence the direct tax collections might decline!

On the other hand, the Government’s plan to sell off the public sector assets hasn't taken off! For instance, its ambitious Air India sale is under the clouds now, with Cairn suing the company to claim its arbitration award!

Moreover, the Government is walking a tight fiscal rope, having budgeted for a 6.8% fiscal deficit for FY22, down from 9.5% in FY21. Any slippages in revenues could also jeopardize the efforts to achieve the target! Also, the Government has a huge borrowing program of Rs 12.06 Lakh Crore!

And if you account for all of this, you would realize why they say this dividend is a ‘bonanza’ for the Government! As reports note, the dividend could compensate for up to a 2.5% decline in revenues estimated for FY22. Also, it would provide the government with a buffer as it accounts for 3% of the fiscal deficit number.

And with some respite to its finances, the dividend income would allow it 'more room to spend'. Probably, the Government can go out, foot the bills, repair the troubled healthcare infrastructure, and boost the economy. Hopefully so!

So, now you know why the RBI’s dividend is nothing less than a godsend for the Government!

The Bottom Line

Keeping the healthcare and economic picture in mind, it’s only natural to assume that money printing by the RBI is justified. Because if not now, then when, eh?

While in a pandemic, a large surplus transfer isn't dangerous per se, the long-term impact could be detrimental to the cause! If the money enters and floods the economy, prices could go out of control, leading to hyperinflation - a catastrophe in itself! And then, it would be a double whammy for the economy - meager earnings and high prices! Albeit, only time will tell.

Long story short, the RBI seems to be on a slippery slope concerning the size of the dividend and the manner in which it has generated the surplus. However, we leave this bit for the intellects to evaluate how justified this transfer was. And, the best we can do is to hope. To hope that the macro figures don’t turn unstainable anytime soon, so much so that we regret this attempt at monetization. To hope that the benefits of this bonanza outweigh the risk of inflation.

All hail the RBI lord.

Anyway, what’s your take on this? Tell us in the comments below.