06 Feb 2018 16:37 IST

Why the Centre has assumed a lower dividend from the RBI in the next fiscal

Interest outgo on reverse repo operations and possible transfer to contingency fund could be the reason

While lower dividend payout by the RBI had led to a shortfall in its non-tax revenues for 2017-18, it appears that the Centre is once again bracing itself for RBI’s tightfistedness in the next fiscal. For 2018-19, proceeds from dividends from RBI, nationalised banks and financial institutions has been pegged at ₹54,817 crore, only 6 per cent higher than that in the previous year.

The Centre had raked in ₹51,623 crore in 2017-18, far lower than the budgeted ₹74,901 crore, due mainly to a shortfall of nearly ₹ 35,000 crore by way of dividend from RBI. The RBI’s surplus transfer to the Centre was impacted by lower income, higher expenses and a transfer of ₹13,140 crore to its contingency fund. (RBI’s accounts impact Centre’s fiscal with a one year lag due to cash accounting.)

What has led the Centre to keep its expectations modest for the coming fiscal too?

Continued reverse repo operations by the RBI to absorb excess liquidity and factoring in the possibility of transfer of some portion of surplus to the contingency fund, appear to be the two key reasons for the Centre’s muted forecast for 2018-19.

Surplus in the system

According to RBI’s 2016-17 accounts, on the expenditure front, the cost of printing notes, which had more than doubled from the previous year due to demonetisation, had cost the RBI dear. On the income side, the sharp fall of 23 per cent was due to interest outgo by the RBI on its LAF operations (liquidity adjustment facility).

Banks can borrow money for the short term from the RBI under the liquidity adjustment facility (LAF). Alternatively, banks can lend their excess funds to the RBI through reverse repo (absorption of liquidity). Net interest on LAF operations had slipped from a positive ₹506 crore in 2015-16 to a negative of ₹17,426 crore in 2016-17, due to interest outgo on reverse repo operations. This had impacted RBI’s income.

While the net average absorption of liquidity under LAF was the highest in the months ensuing demonetisation in November 2016, it was sizeable even after March 2017 until October 2017. Hence, the RBI’s income for 2017-18 is also likely to be impacted by the interest payout on reverse repo operations. Average net absorption by the RBI had spiked to ₹4.4 lakh crore in March 2017.

Variable rate reverse repo auctions averaged Rs 3.8 lakh crore in April and was ₹3.4 lakh crore in May 2017. Net average absorption of liquidity under the LAF stood at ₹3 lakh crore in July, ₹2.22 lakh crore in September and ₹1.4 lakh crore in October. While the numbers have been trending lower, they are still sizeable to impact RBI’s net income on account of interest payout.

Re-building its kitty?

Aside from the dip in income, the RBI transferring ₹13,000 crore of surplus to its contingency fund in 2016-17, had also impacted the dole-out to the Centre last year. Additions to this fund had ceased since 2013-14 and the entire surplus in the RBI’s coffers was being transferred to the Centre up until last year. The RBI had been contributing a chunk of its profit to the contingency fund up to 2012-13; between 2010-11 and 2012-13 the RBI had set aside 32-45 per cent of its gross income to this fund.

The debate on how much the RBI should transfer to its contingency reserves has once again taken centre-stage. Contingency reserve represents the amount set aside for meeting unexpected and unforeseen contingencies, including depreciation in the value of securities, risks arising out of monetary/ exchange rate policy operations, systemic risks, etc. In the past, two internal working groups V Subrahmanyam Group in 1997 and Usha Thorat Group in 2004 had given their recommendations on how much contingency reserve is adequate. The former suggested internal reserves (Contingency Fund and Asset Development Fund) of 12 per cent of total assets, while the latter is about 18 per cent.

The RBI’s reserves were about 10-11 per cent of total assets between 2009-2011. It has been slipping since then and in 2015-16 and 2016-17 stood at a much lower 7.5 per cent of total assets. If the RBI chooses to rebuild its kitty and continues to transfer funds to its reserves, it could once again impact the dividend payout to the Centre.

(The article first appeared in The Hindu BusinessLine.)