In today's Finshots, we talk about the huge surplus that the RBI will transfer to the government.

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The Story

₹2.1 lakh crore.

This is the money RBI (Reserve Bank of India) is expected to transfer to the government. And we are sure at this point you’re asking yourself.

Where did this money come from?

And why is the RBI transferring this money to the government?

So let’s begin with the first question. The source of the funds.

Technically, speaking, this shouldn’t be too hard to answer. RBI is a bank. And like all banks, RBI does a fair bit of lending. And when they lend money, they generate income by charging an interest on the principal. Some of this money is categorised as surplus.

RBI also routinely buys and sells government bonds. And when you buy and sell stuff, you can sometimes walk away with a profit. So there’s that.

RBI also invests some of its money in foreign assets. These generate income too and finally; RBI has the exclusive right to issue currency in India. While printing money doesn’t directly generate a profit, there is this idea called seigniorage. It’s the difference between the face value of money and the cost to produce it. For example, it costs less to print a 100-rupee note than its face value of 100 rupees. And therein lies more profit.

Put together RBI has many ways to make money.

So it shouldn’t be a surprise that the RBI can simply give away ₹2.1 lakh crore to the government.

The more challenging question is — Why is RBI transferring this money to the government?

Is the RBI trying to appease the government during an election year? Or even worse, raiding the RBI’s coffers and undermining the central banks’ authority.

Well, here’s the thing.

Back in 2019, there was indeed widespread speculation that the government was trying to force the RBI to part with its reserves unilaterally by invoking an obscure clause in the RBI Act. However, better sense prevailed. Instead, the government decided to do away with any plans of raiding the RBI’s reserves and instituted a panel to determine whether the RBI was, in fact, sitting on needless cash. They said that they would act only based on the recommendations of the panel.

The idea was to put together an independent committee, headed by accomplished non-partisan individuals and get them to look into this matter of “surplus reserves”. It proceeded with the help of an external committee headed by Bimal Jalan, a former RBI governor. The committee looked at the RBI’s reserves, evaluated the rainy-day fund i.e. part of the reserves RBI would need, just in case things go wrong. And finally, after accounting for all contingencies recommended transferring whatever remained on top.

And ever since then, the RBI has been using these recommendations to work the transfer. In fact, this time, the board was even more conservative while deciding on their rainy-day fund (contingency fund). So there’s no reason to believe that the government has any role to play in deciding the kind of money RBI transfers from its kitty.

Second, you have to realise that the RBI isn’t in the business of making money. Any profit they generate is simply incidental. Their primary objective is to foster “price stability” — to tame inflation. And through it, they support long-term economic growth. Any profit they make in the process is just a byproduct of their operations, not the primary goal.

However, once there’s excess reserve in their account you can make a compelling argument that the RBI should transfer the surplus to the government so that the government can then spend this money elsewhere.

So how will the government use this money?

Well, it’s hard to say. For starters, even the government is surprised by the quantum of transfer. We know this because when they were preparing the budget last year, they assumed the RBI would transfer about ₹1 lakh crores. This is more than double that sum. So this will definitely lift up their spirits.

That being said the government will likely use this money to pare down debt. So far, they’ve been borrowing a lot of money to support India’s growth objectives. However, going overboard with debt will send the wrong message and last year they promised to work on this. Also, some people are hoping that this money could force the government to rethink taxes. If there’s not enough pressure on the government to generate revenue through taxes (because of the surplus), maybe common people will end up parting with less.

Will it happen?

We don’t know. But we hope that the money is put to good use.

Until then…

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