On May 22, the Reserve Bank of India (RBI) announced an unprecedented surplus transfer of Rs 2.22 lakh crore to the government, sparking widespread speculation. This amount is significantly higher than the Rs 1 lakh crore the government had anticipated in its budget. This surplus transfer was executed based on the Economic Capital Framework (ECF) adopted by the RBI on August 26, 2019, following recommendations from the Bimal Jalan committee.
Adding to the surprise, the RBI managed to accumulate over Rs 2 lakh crore despite increasing the contingency risk buffer (CRB) to 6.5 percent from the previous 6 percent. The CRB acts as a financial cushion for the central bank, mandated by Basel norms, and the 6.5 percent level is at the upper end of the range specified by the Jalan committee.
Since the announcement, media speculation has surrounded the exact calculations leading to this significant surplus. However, the RBI’s annual report released on May 30 provides clarity on the factors contributing to the Rs 2.11 lakh crore surplus.
Before delving into the numbers, it’s essential to understand why the RBI transfers surplus to the government. Like any company distributing dividends from its profits to shareholders, the RBI, which is owned by the government, transfers its excess earnings. Established in 1935 as a private bank, the RBI was nationalized in January 1949, making it a government-owned entity. Hence, the transfer is termed a surplus rather than a dividend.
The legal basis for the RBI’s surplus transfer lies in Section 47 of the RBI Act, which mandates that after provisioning for bad debts, asset depreciation, and other necessary expenses, the remaining profits must be paid to the central government. This transfer is typically approved by the RBI’s central board in May each year.
Beyond its role as a banking regulator and currency issuer, the RBI engages in extensive treasury operations both domestically and internationally. This includes foreign exchange transactions and income from government securities and investments in global central banks’ securities. The RBI also incurs expenses such as currency printing, staff salaries, and commissions to banks and primary dealers for government transactions.
The RBI’s latest annual report reveals a 17 percent increase in income for FY2023-24, primarily due to a significant rise in interest income from foreign securities, which jumped to Rs 65,327.93 crore from Rs 43,649.26 crore in FY23. Additionally, the RBI’s foreign currency assets increased by about 14 percent. Consequently, income from foreign sources rose by 23 percent year-on-year to Rs 1.8 lakh crore, while domestic income increased by around 6 percent to Rs 88,100 crore.
Overall, the RBI’s total income surged to Rs 2.76 lakh crore in FY24 from Rs 2.46 lakh crore the previous year. Meanwhile, expenses dropped to Rs 64,694.33 crore from Rs 1.48 lakh crore, primarily due to lower unrealized mark-to-market (MTM) losses on security holdings as yields softened. This reduction in expenses, despite the increased CRB, enabled a record surplus.
Subtracting total expenses from total income (Rs 2.76 lakh crore minus Rs 64,694 crore) results in the Rs 2.11 lakh crore surplus. On May 22, the RBI’s Central Board approved this transfer to the government, marking the highest-ever yearly surplus transfer by the Indian central bank. Previously, the highest transfer was Rs 1.76 lakh crore in FY 2018-19.
This record transfer is attributed to a surge in interest income and lower-than-expected expenditures, rather than government pressure for larger transfers to aid fiscal management.
Predicting the surplus for FY25 is challenging and depends on global interest rates and economic conditions. If global rates remain high, the RBI’s foreign currency assets and gold reserves could yield substantial income. Conversely, potential rate cuts by the Federal Reserve and their impact on domestic yields could reduce unrealized MTM losses, possibly turning them into profits and reducing the need for provisions.
The CRB might not need to stay at the higher end if the banking system’s health improves and systemic risks decline. According to an Emkay report, a possible review of the framework could provide the RBI with more flexibility for dividends and its foreign exchange management strategy.
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