What are these reserves, how will this amount help the Central government and does this move harm the RBI?

The Reserve Bank of India (RBI) has decided to transfer ₹1.76 lakh crore to the Central government from its own reserves. What are these reserves, how will this amount help the government and does this move harm the RBI?

Where do the reserves come from?

To understand what the transfer is, we must first understand where the funds come from. The central bank has three different funds that together comprise its reserves. These are the Currency and Gold Revaluation Account (CGRA), the Contingency Fund (CF) and the Asset Development Fund (ADF). Of these, the CGRA is by far the largest and makes up the significant bulk of the RBI’s reserves. The fund, which in essence is made up of the gains on the revaluation of foreign exchange and gold, stood at ₹6.91 lakh crore as of financial year 2017-18. The CGRA has grown quite significantly since 2010, at a compounded annual growth rate of 25%.

The CF is the second biggest fund, amounting to ₹2.32 lakh crore in 2017-18. It is designed to meet contingencies from exchange rate operations and monetary policy decisions and is funded in large part from the RBI’s profits.

The ADF makes up a much smaller share of the reserves.

How much should the RBI keep?

This has been a contentious issue. The RBI and the Finance Ministry have been at loggerheads over how much should be transferred to the Centre for a while. The most recent boiling over of tensions between the two was when the then RBI Deputy Governor, Viral Acharya, spoke up about the dangers of governments infringing upon central bank autonomy. One of the ways this was happening, he said, was in the government raiding the RBI’s coffers. The government countered that the RBI had reserves far in excess of what the global norms were and, so, should transfer the excess.

Finally, the government in November 2018 set up a committee under former RBI Governor Bimal Jalan to look into the issue. That committee submitted its report, and the recent transfers have been made on the basis of its recommendations.

What did the Jalan Committee recommend?

The Jalan Committee, as it was called informally, is actually called the Expert Committee to Review the RBI's Extant Economic Capital Framework.

The committee recommended that the RBI maintain a Contingent Risk Buffer — which mostly comes from the CF — of between 5.5-6.5% of the central bank’s balance sheet. Since the latest CF amount was about 6.8% of the RBI’s balance sheet, the excess amount was to be transferred to the government. The committee also decided, for the year under consideration, to use the lower limit of 5.5% of the range it recommended. So, basically, whatever was excess of 5.5% of the RBI’s assets in the CF was to be transferred. That amount was ₹52,637 crore.

Regarding the RBI’s economic capital levels — which is essentially the CGRA — the committee recommended keeping them in the range of 20-24.5% of the balance sheet. Since it stood at 23.3% as of June 2019, the committee felt that there was no need to add more to it, and so the full net income of the RBI — a whopping ₹1,23,414 crore — should be transferred to the Centre.

That ₹1.23 lakh crore plus the ₹52,637 crore is what comprises the ₹1.76 lakh crore that the RBI has decided to transfer to the government. It must be noted that this ₹1.76 lakh crore includes the ₹28,000 crore interim dividend earlier transferred to the Centre and does not come over and above it.

Does this harm the RBI?

While it does not immediately do the RBI any harm, the fact remains that the central bank now has far less wiggle room in the event of a financial catastrophe, since its reserves have been emptied to their minimum levels or thereabouts. That is, it has the minimum amount to deal with a crisis, but extra cash always comes in handy.

That said, given that the RBI’s transfers have now been as emptied as they can be, there is no scope for the government to rely on this source of funding in the near future. The government in its Budget already accounted for a transfer of ₹90,000 crore from the RBI, and so the unexpected amount is ₹86,000 crore. This is a one-time bonanza and does not fix the fact that tax revenues — both direct and indirect tax — are coming in much lower than they need to.