By Prashansa Srivastava
Implying lesser non-tax revenues to the government this year, the Reserve Bank of India (RBI) on 10th August approved the transfer of surplus amounts of only INR 30,659 crore to the government for the year ended June 2017. This year, the amount will be less than half the amount of INR 65,876 crore that was transferred last year.
RBIs profit mechanism
Like all profits, the RBIs profit essentially represents the difference of income over expenditure. The key source of income for the Central Bank is the interest arising from its foreign and domestic assets. A report by Economic Times states that a bulk of the income for the central bank is interest income, of which nearly 60 per cent is interest earned on domestic bond holdings. It also includes interest earned on bond holdings through open market operations or purchase and sale of government securities.
Reasons for the decline
Though the apex bank is tight-lipped about the reason for such a steep slide, the dip in the transfer of surplus this year may be because of various factors related to demonetisation. RBIs costs skyrocketed due to additional printing and destruction of scrapped notes. The subsequent cost of managing excess liquidity due to the phasing out of INR 500 and 1000 notes further ate into the surplus of the RBI. Removing, and replacing notes, while printing new notes further drove up costs. By removing the INR 1000 note, the government also did away with the cheapest note to print in relation to the face value of the note that is 0.3 % of the face value.
The surplus domestic liquidity forced the RBI to undertake reverse-repo auctions. Reverse-repo auctions remove excess cash in the system and absorb liquidity caused by the post-demonetization cash flood. These further added to the costs of the RBI since the RBI has to pay interest on this money to banks. The Central Bank would have paid, on an average, 6 per cent interest to banks to drain the excess liquidity. This was in sharp contrast to liquidity being in deficit in prior two years, which saw banks borrow from the RBI and add to the latters earnings. Also, in the midst of weak global yields, there were also lower returns on foreign reserves. The twin reasons of low returns and high costs led to the small surplus.
A precarious situation
The excess liquidity in the banking system seems to have taken a heavy toll on the Reserve Bank of Indias payout to the government. This low payout will burn a deep hole in the State exchequer. The decline will hit the government hard as it could make it very difficult for meeting its fiscal deficit target of 3.2 percent of gross domestic product for the year ending in March.
A high government deficit leaves little for the private sector for investment and puts upward pressure on interest rates also referred to as crowding out. Lower savings and slower growth are further associated with a high fiscal deficit. Delay in fiscal adjustment does not reflect well on the governments economic management abilities and adversely affects investor confidence. It also reduces the capacity of the state to lend any support to the economy in case growth slips.
The high deficit will automatically impact several welfare measures and the large shortfall of INR 35,000 crores will be reflected in lower government spending. The government will now have to undertake prudent revenue operations to make up for this national loss. Given RBIs figures, it has become evident that other public banks will fare worse, thus giving rise to the grim prediction that fiscal deficit might increase from 3.2 per cent to 3.4 per cent this year.
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