Is the RBI paying too much dividend?

Is the RBI paying too much dividend?: The central bank is undercapitalised; it should reconsider these payouts to the Government. Risky foreign assets are a problem...


"What are the implications of this trend for the RBI’s own capital needs? For a variety of reasons, chief being providing exchange rate guarantee for free on FCNR deposits, the RBI’s capital stood significantly depleted in the early 1990s. In response, a policy decision was taken in 1997 to retain a good portion of the RBI’s profit each year till the ratio of its internal reserves (Contingency Fund and Asset Development Fund) reached 12 per cent of its assets. In the case of the RBI, its internal reserves are almost identical with its usable equity (equity that can be freely used to meet any kind of financial loss), since the other components, like paid-in capital, are insignificantly small.
Pursuance of this approach yielded good results. The ratio of internal reserves to total assets rose steadily, exceeding 12 per cent in 2009-10 and remaining close to 12 per cent in the following year. It fell in the subsequent years and currently it is at 7.5 per cent. The last three years have witnessed a sharp reversal of the strength of the usable equity of the RBI."

This is what Raghuram Rajan said at St Stephen’s College, New Delhi on September 3, 2016:

“How does the RBI generate surplus profits? We, of course, print the currency held by the public, as well as issue deposits (i.e. reserves) to commercial banks. Those are our fixed liabilities. As we issue these liabilities, we buy financial assets from the market. We do not pay interest on our liabilities. However the financial assets we hold, typically domestic and foreign government bonds, do pay interest. So we generate a large net interest income simply because we pay nothing on virtually all our liabilities. Our total costs, largely for currency printing and banker commissions, amount to only about 1/7th of our total net interest income. So we earn a large surplus profit because of the RBI’s role as the manager of the country’s currency. This belongs entirely to the country’s citizens. 3 Therefore, after setting aside what is needed to be retained as equity capital to maintain the creditworthiness of the RBI, the RBI Board pays out the remaining surplus to the RBI’s owner, the Government. The RBI Board has decided it wants the RBI to have an international AAA rating so that RBI can undertake international transactions easily, even when the Government is in perceived difficulty – in the midst of the Taper Tantrum, no bank questioned our ability to deliver on the FCNR(B) swaps, even though the liability could have been tens of thousands of crores. Based on sophisticated risk analysis by the RBI’s staff, the Board has decided in the last three years that the RBI’s equity position, currently around 10 lakh crores, is enough for the purpose. It therefore has paid out the entire surplus generated to the Government, amounting to about Rs 66,000 crores each in the last two years, without holding anything back. This is of the order of magnitude of the dividends paid by the entire public sector to the Government. In my three years at the RBI, we have paid almost as much dividend to the government as in the entire previous decade. Yet some suggest we should pay more, a special dividend over and above the surplus we generate. Even if it were legally possible to pay unrealized surplus (it is not), and even if the Board were convinced a higher dividend would not compromise the creditworthiness of the RBI, there is a more fundamental economic reason why a special dividend would not help the Government with its budgetary constraints. Here’s why: Much of the surplus we make comes from the interest we get on government assets or from the capital gains we make off other market participants. When we pay this to the government as dividends, we are putting back into the system the money we made from it – there is no additional money printing or reserve creation involved.2 But when we pay a special dividend to the government, we have to create additional permanent reserves, or more colloquially, print money. Every year, we have in mind a growth rate of permanent reserves consistent with the economy’s cash needs and our inflation goals. Given that budgeted growth rate, to accommodate the special dividend we will have to withdraw an equivalent amount of money from the public by selling government bonds in our portfolio (or alternatively, doing fewer open market purchases than we budgeted).”

M G Warrier


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