The Central Board of Directors, Reserve Bank of India on May 22, 2024, decided to transfer the highest-ever surplus income (profit) of ₹2.1 trillion to the government. How was it possible to earn such a large amount of profit in FY24? Will it stoke inflation in the economy? Is it desirable to transfer such a large sum to the government? An attempt has been made here to answer these questions.

The RBI earns income from both domestic assets (sovereign papers) and foreign assets. The rate of earning from domestic assets is typically higher than that from foreign assets due to the difference in yield between the domestic and foreign assets. After structural reforms implemented since 1991, the composition of RBI’s assets has undergone a sea change in favour of foreign assets. Earning from foreign assets has not been impressive since the global financial crisis due to low interest rates prevailing in Western countries.

During 2023-24, earning from foreign assets was significantly high following relatively higher interest rates prevailing in Western countries throughout the year due to tight monetary policy pursued by them. During the second half of 2023-24, RBI earned a good amount of income from commercial banks as the daily average injection of liquidity was ₹1 trillion as against net absorption earlier in the post-Covid period. Profit was also booked as and when RBI sold foreign exchange at an exchange rate higher than the weighted average cost (holding rate).

According to the details available from the latest RBI Annual Report, total expenditure in FY24 was ₹64,694 crore, which was way below the ₹1,48,037 crore in FY23 mainly due to a drastically low level of provisioning requirement at ₹42,820 crore in FY24 as against ₹1,30,876 crore in FY23. Due to the softening of yield (corresponding increase in asset prices), the need for the provisioning requirement was reduced in FY24.

Transfers inflationary?

In an accounting sense, profit transfer per se neither affects the size of the RBI balance sheet nor contributes to the reserve money expansion. The balance sheet size remains unchanged as the undistributed profit, which is a part of RBI’s other liabilities, is reduced and simultaneously the central government’s balance with RBI is increased, one offsetting the other. While computing the reserve money, a fall in the non-monetary liability due to profit transfer is offset by a decline in the net RBI credit to the central government. Consequently, there is no reserve money expansion that causes inflation.

However, as soon as the government starts spending from the profit received from the RBI, reserve money expansion takes place, which may contribute to inflation. Counterarguments are also available in the literature. Anything RBI earns becomes a non-monetary liability till it remains in its balance sheet. For its productive use, this should go back to the economy through profit transfer to the government. Being the owner of RBI, the government has a rightful claim over the seigniorage revenue. Budgetary provision is made every year about the transfer of profit to the government by PSUs, including profit from the RBI. This year’s profit transfer exceeded the budgetary provision by a wide margin. A large profit transfer either reduces government borrowing or offsets revenue shortfall from other segments like disinvestment.

According to conventional wisdom, large fiscal deficits significantly contribute to inflation. Fiscal profligacy has been a cause for concern leading to inflation everywhere due to Covid-related expansionary budgets since 2020. In India too, both Central and State governments deviated from the fiscal discipline embedded in the FRBM Act. However, the burden of Covid-19 management in India fell largely on the RBI. The cash outgo from the budget was limited and the fiscal deficit was prudentially managed compared to many other countries. Currently, the government has a medium-term strategy of reverting to fiscal discipline in a time-bound manner. Large profit transfer by RBI allows the government to pursue capex-heavy fiscal consolidation. In that sense, large profit transfers from the RBI may not necessarily be inflationary.

The paid-up capital of the RBI is negligible. Hence, there is a need for provision towards a contingency risk buffer (CRB). In India, the requirement of contingency reserves (asset development reserves included) was examined several times by different working groups. The earlier working groups recommended maintaining CRB at 12 per cent of the total assets. A part of the profit was therefore appropriated towards contingency reserves every year before the profit was transferred to the government. Recently, the Bimal Jalan Committee revisited the issue and recommended that RBI should maintain CRB (available realised equity) ranging from 5.5-6.5 per cent of total assets as the economic capital, which includes a large balance built up under the CGRA (Currency and Gold Revaluation Account), is fairly robust and one of the highest among its peers. A higher level of CRB was relevant when the CGRA balance was low.

Due to the prevailing macroeconomic conditions and Covid-related requirements, the RBI maintained CRB at 5.5 per cent of total assets from 2018-19 to 2021-22 and transferred the remaining surplus to the government. As the macroeconomic conditions improved, the CRB was raised to 6 per cent in 2022-23 and further to the upper limit of 6.5 per cent of total assets in 2023-24 before the profit transfer. If the RBI balance sheet is fairly strong, particularly due to pursuance of conservative accounting practices, seigniorage revenue in any year would depend on surplus income over expenditure (including provision), irrespective of its size.

In India, inflationary pressure is receding slowly like in many other countries. Core inflation is well below 4 per cent. Food inflation, which remains elevated, may converge to the target as the South-West monsoon is predicted to be normal in 2024. The real economy is performing near its potential. Hence, overheating fear is yet to emerge. Rural demand, which has been sluggish for some time, may revive soon and help sustain growth. A handsome profit transfer from RBI in such a situation would contribute to a capex-heavy fiscal consolidation, contain twin deficits and impart macroeconomic balance.

The writer is RBI Chair Professor at Utkal University and former Principal Advisor and Head of the Monetary Policy Department of RBI. Views are personal