RBI dividend windfall: HSBC predicts looser banking system liquidity over the year

The Centre may consider using some of the RBI dividend windfall of ₹ 2.1 lakh crore to replenish its welfare schemes, HSBC Global Research has said. 

Weak consumption growth, particularly in the mass markets in India may, prompt the government to shift the focus of this dividend bounty towards current expenditures, Pranjul Bhandari, Chief Economist, India and Indonesia, said in a note on ‘How will the RBI Dividend be used?’.

• Editorial.Fiscal dividend

This is interesting as the government’s dominant spending thrust has been on capex over the last few years. Even in the current fiscal year, there is a provision for a 17 per cent increase in funding.

She highlighted that current expenditures, particularly on social schemes, are budgeted to fall sharply in the interim budget (by 0.6 per cent of GDP in FY25).

SPEND or SAVE the BOUNTY?

Discussing how the government could use this dividend bounty, Bhandari said that the Centre could either save it or spend it or even do a bit of both (spend a bit, save a bit).

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On the issue of saving the bounty, Bhandari said that the government can use these funds to lower the fiscal deficit and hence borrowing. This will not just improve the demand-supply math of the government’s borrowing programme but also be positive for banking sector liquidity over the year (by cutting back on government borrowing, which would have taken out domestic liquidity).

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Rather than save the bounty, the government could choose to spend it, she added. “To be fair, the government can also do a bit of both —spend a bit, save a bit. Either way, banking system liquidity would be looser over a year. Within that, durable liquidity will rise immediately, banking system liquidity will follow as the government gradually spends or cuts borrowing”, Bhandari said.

“It will all be known when the new government presents the budget in July. Hold your breath”.

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RBI on Wednesday said that it has transferred a record-high dividend of ₹2.1 lakh crore (0.6% of GDP) to the central government for FY24. This is the highest surplus transfer by the central bank over the last ten years since the Modi-led Government first came into office in 2014.

“By our estimate, this is about 0.3 per cent of GDP higher than what the government had budgeted in its interim budget back in February. As such, it’s extra money in the government’s pocket,” Bhandari said.

WHERE DID IT COME FROM?

This bounty came from a couple of sources, but two stand out: Interest earned on foreign currency assets. India parks much of its foreign currency reserves in advanced economy bonds. These reserves rose sharply over the year (by USD61bn in FY24). Marrying the rise in reserves with higher yields in advanced economy government bonds (led partly by policy rate hikes in FY24) points towards higher interest income, according to HSBC Global Research. 

The second main source is the higher sale of foreign exchange: In its efforts to keep the rupee stable, the RBI sold $153 billion of its FX reserves over the year. The wedge between the purchase price and the sale price of the dollars sold, in a first-in-first-out system, is likely to have added to its profits, it added.

“In short, the external environment – higher global interest rates and USD volatility – seems to have contributed to RBI profitability,” Bhandari said.