The Transfer Of Surplus Is Not A Raid On RBI’s Balance Sheet, Says Rakesh Mohan

Bimal Jalan-committee member Rakesh Mohan explains key aspects of the recommendations on transfer of RBI surplus.

Rakesh Mohan, previously deputy governor of RBI, at a banking conference in Mumbai (Photographer: Prashanth Vishwanathan/Bloomberg)
Rakesh Mohan, previously deputy governor of RBI, at a banking conference in Mumbai (Photographer: Prashanth Vishwanathan/Bloomberg)

The central board of the Reserve Bank of India has approved a transfer of Rs 1.76 lakh crore to the government of India, after considering the recommendations of a committee set up to review the central bank’s Economic Capital Framework.

The committee, headed by Bimal Jalan, also included former RBI Deputy Governor Rakesh Mohan, central board members Bharat Doshi and Sudhir Mankad, Economic Affairs Secretary Subhash Chandra Garg and RBI Deputy Governor NS Vishwanathan. Garg was later replaced by Rajeev Kumar as the government nominee.

While the RBI is yet to release the full report, the central board’s statement explained that the committee had made two key recommendations:

  • Maintaining a comfort level of 5.5-6.5 percent for the contingency reserves. The central board decided to keep the reserves at the lower end of that band from the current 6.8 percent. As such, an excess amount of Rs 52,637 crore is being transferred to the government.
  • The committee also said that if the RBI’s economic capital is within the acceptable range of 20-24.5 percent of the balance sheet, the central bank can transfer its entire net income for the year to the government. As such, a net income of Rs 1,23,414 crore is being transferred to the government. Of this, Rs 28,000 crore has been transferred as interim dividend already and used as part of FY19.
Net-net, the Centre gets Rs 1,48,051 crore for FY20 compared to the budgeted Rs 90,000 crore, providing some relief for government finances.

Understanding The Transfer

BloombergQuint spoke to Rakesh Mohan, vice-chairman of the Economic Capital Framework Committee and former deputy governor of the Reserve Bank to understand key aspects of the recommendations.

Some of the key questions and Mohan’s explanations are detailed below.

Q: How did the committee arrive at the optimal level for contingency reserves?

Mohan said the committee had examined practices of other central banks and found that there is no one international standard. Since the policy mandates of central banks differ, comparing the RBI’s economic capital with other central banks is actually not very useful, said Mohan.

According to the statement released by the RBI central board, the committee recommended the adoption of ‘Expected Shortfall’ methodology under stressed conditions in place of the currently followed ‘Stressed-Value at Risk’ methodology.

Based on this, the committee recommended a range of 5.5-6.5 percent of balance sheet for the contingency reserve. The central board chose to take the contingency reserves down to the lower bound.

On the issue whether you take the upper bound or lower bound, the central board has to look at the expectation of risk materialising or not materialising, looking at the market situation in the country and abroad. Based on that, you would decide what kind of risk reserves you want to maintain.
Rakesh Mohan, Vice-Chairman, Economic Capital Framework

Q: How did the committee treat revaluation reserves?

The RBI’s balance sheet also carries revaluation reserves. This ‘reserve’ is essentially an accounting entry based on the current value of the foreign and domestic assets that the RBI holds on its balance sheet. As the committee started deliberations, questions were asked on how the panel would treat this.

Mohan explained that the committee stuck to the standard accounting principle that revaluation reserves are simply an accounting entry. “The standard accounting principle is that you do not distribute unrealised gains so we observed the standard accounting principle,” Mohan said.

The revaluation reserves do not arise not from any realised gains, but basically market accounting gains because of the changes in the value of the rupee with respect to the foreign exchange reserves. Therefore, one principle we observed is the revaluation reserves cannot be distributed. Essentially they account for the market risk that the RBI faces and thus the market risk is then well taken care of by the revaluation reserves. The issue then boils down to other non-monetary liabilities, how much do you need?
Rakesh Mohan, Vice-Chairman, Economic Capital Framework

Q: So, how did the RBI generate such a large surplus in FY19?

The central board statement says that the transfer of Rs 1,76,051 crore includes a surplus of Rs 1,23,414 crore for FY19. Of this, Rs 28,000 crore has already been transferred to the government. The remaining will be transferred during the ongoing financial year.

This surplus transfer is one of the largest on record. Last year, the RBI had transferred Rs 50,000 crore to the government.

While the RBI is yet to release the full accounts for the year, Mohan said there could be a simple reason for the large surplus generated by the central bank last financial year. Due to tight liquidity conditions, the RBI conducted open market operations to purchase large amounts of government bonds and infuse liquidity into the domestic market. This would have resulted in high income for the central bank.

I haven’t seen the accounts but I think it’s a very simple answer. The RBI did a very large amount of OMO last year in 2018-19, amounting to almost 70 percent of all of total government borrowing. Therefore, the absolute stock and the proportion of government securities on the asset side (of RBI’s balance sheet) went up significantly. Since domestic government securities have a significantly higher interest rate than the foreign securities, therefore you get a larger surplus and revenue. I have not seen the accounts but that would be the logical explanation.
Rakesh Mohan, Vice-Chairman, Economic Capital Framework

Q: Is this a raid on the central bank’s balance sheet?

The prelude to the setting up of the committee on the RBI’s Economic Capital Framework was messy. Government officials believed the RBI was sitting on excess capital and could transfer some of this to the central budget. The RBI, under former governor Urjit Patel, disagreed. After Patel quit abruptly, questions were raised as to whether the government was looking to ‘raid’ the central bank’s balance sheet.

Should the seemingly large transfer be seen as that? Mohan says it should not.

I will repeat that I don’t have access to the final accounts of the RBI for 2018-19 because they were just submitted to the board today. Just going by the press release, it would seem that they have followed the report of the committee.
Rakesh Mohan, Vice-Chairman, Economic Capital Framework

Mohan said the committee’s report was unanimous and signed by all members including government representative Rajeev Kumar. Mohan declined to comment on whether former economic affairs secretary Subhash Chandra Garg had issued a dissent note on the committee’s recommendations.

Watch the full discussion here: