All you wanted to know about seigniorage

There is a heated debate about the RBI’s decision to slash its dividend payout to the Centre by half, to ₹30,659 crore. Analysts have come up with a battery of reasons from the higher interest costs paid by the RBI to banks after demonetisation, to a bigger transfer to the contingency reserve to the loss incurred on seignorage. The last is the surprise element because seigniorage usually results in windfall profits for central banks and governments.

Seigniorage is a fancy term for the profits governments make by minting currency. It is the difference between the face value of a currency note or coin, and its actual production cost. For instance, if the cost of printing a ₹2,000-note is about ₹4, printing one such note and putting it into circulation fetches a profit of ₹1,996. Usually central banks ‘earn’ this profit and transfer it to the Government.

It is normal to assume that whenever the it issues new currency, the RBI will pocket a profit. Higher denomination notes earn higher profits. However, things are different in the case of coins where the cost of minting can is usually equal to the face value, and can fluctuate based on the price of base metal.

Unusually, in FY17, the RBI made a loss from seignorage. When demonetisation was announced, it had to call back and extinguish all the ₹500 and ₹1000 notes in circulation. Nearly ₹15.4 lakh crore (face value) worth of currency was demonetised and 90 per cent of it had to be reprinted within the year. Normally, the RBI would have made profits on issuing new currencies of high denomination; instead it made losses as it had to replace older notes.

According to its income statement, the cost of printing notes increased from ₹3421 crore in FY16 to ₹7965 crore in FY17. The lumpy cost of printing as well interest foregone by the RBI to banks who placed their excess deposits in the LAF window (because of demo) are mainly blamed for lower transfers to the Government. SBI’s chief economist noted in a recent research report that seigniorage loss and the extra interest that the RBI paid, took out ₹26,000 crore from its dividend payout this year. Had the note ban resulted in a lot of money not returning to the RBI, the windfall profit from could have made up for the seigniorage loss. But that didn’t happen.

The Centre has budgeted for about ₹75,000 crore by way of dividends from the RBI, nationalised banks and financial institutions. While the break-up was not given, last year ₹65,876 crore was paid out by the RBI itself as dividends to the Government. So, in a sense, the RBI’s dividend was expected to make up a major chunk of dividend receipts projected for FY18. But a more than 50 per cent fall in such transfers could mean the Centre’s fiscal math could go for a toss. This will have to be made up by better tax collections. Slippage of fiscal targets could prove inflationary and lead to lower developmental spends by the government.

However, don’t give up hope. The demonetisation exercise and Operation Clean Money are said to have increased the number of direct taxpayers sharply. If these taxpayers help the Government garner additional revenues in the form of taxes, the hole left by RBI dividends could be filled. SBI puts such incremental revenue at about ₹20,000 crore.

The face value of the Government depends on the taxes it rakes in for 2017-18.

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