RBI's Record Surplus Transfer to Government of India
(This is for information and educational purposes only. This should not be
construed as a recommendation or investment advice even though the author is a CFA
Charterholder. Please consult your financial adviser before taking any
investment decision. Safe to assume the author has a vested interest in stocks
/ investments discussed if any.)
(Update dated 09Jun2024 is available at the end of the blog)
Reserve Bank of India (RBI), India's central bank, yesterday decided to transfer a surplus of Rs 210,874 crore for the financial year 2023-24. This is the highest surplus the RBI has transferred in any year.
This is an increase of more than 140 per cent versus the FY 2022-23 surplus transfer of Rs 87,416 crore. While increasing the surplus transfer, RBI was able to increase the contingent risk buffer to 6.5 per cent in FY 2023-24 compared to 6 per cent in FY 2022-23.
The following table provides details of RBI surplus transfer, the percentage of contingent risk buffer (CRB), accretion and depletion of foreign currency assets (FCA), rate of earnings on FCA and the US Federal funds rate.
What these terms RBI surplus, CRB and FCA mean will be explained shortly.
Clarification on the above table:
Data in columns 2,3 and 4 (surplus transfer, CRB and rate of earnings) are as per RBI financial year (notes 3 and 4 in the table).
But data in columns 5,6 and 7 (FCA year-end, FCA accretion / depletion and Fed funds rate) are as per Govt of India fiscal year that is, Apr-Mar for all the years.
Data in columns 2,3 and 4 (surplus transfer, CRB and rate of earnings) are as per RBI financial year (notes 3 and 4 in the table).
But data in columns 5,6 and 7 (FCA year-end, FCA accretion / depletion and Fed funds rate) are as per Govt of India fiscal year that is, Apr-Mar for all the years.
1. What is RBI Surplus?
On the assets side of its balance sheet, RBI has holdings of foreign exchange reserves which consist of foreign currency assets, gold, special drawing rights (SDRs) and others.
In addition to foreign assets, RBI also holds domestic securities. From
these domestic securities (in Indian parlance, these are called Government
Securities or G-Secs), RBI receives coupon interest, which is mostly returned
to Government of India.
So, for RBI the major sources of income are foreign and domestic assets.
On the expenditure side, RBI has staff expenses and superannuation funds. In addition, it has to provide for bad and doubtful assets; depreciation in assets and other risk provisions.
The difference between income and expenditure is surplus of RBI, which is transferred to the Government of India every year.
On the expenditure side, RBI has staff expenses and superannuation funds. In addition, it has to provide for bad and doubtful assets; depreciation in assets and other risk provisions.
The difference between income and expenditure is surplus of RBI, which is transferred to the Government of India every year.
The 2018-19 RBI surplus transfer of Rs 175,988 crore includes RBI surplus for the year and excess risk provisions written back as per the recommendations of Bimal Jalan Committee on Economic Capital Framework (ECF).
2. Why the record surplus of Rs 2.11 lakh crore in FY 2023-24?
RBI did not give any specific reasons for the big increase in the surplus for last finanial year (see table above for data for the past 11 years). However, it will give the break-up of the its income and expenditure in its annual report for FY 2023-24, which is likely to be released in the next one week.
The main reasons for the record surplus could be:
a) Interest rates in the US (see Fed funds rate column in the above table) and other major developed economies have been higher in the past two years and RBI may have earned more income from its holdings of foreign currency assets (FCA). RBI deploys a major portion of its foreign assets abroad.
b) RBI may have earned higher gains from its foreign exchange trading as it undertakes purchase and sale of US dollars and Euros as part of its daily intervention to "smoothen excess volatility" in exchange rate. RBI uses both the US dollar and Euro as intervention currencies.
c) RBI's foreign currency assets rose by 12 per cent in FY 2023-24 to USD 571 billion (an addition of USD 61 billion for the year) versus a decline of 5.7 per cent in the previous financial year (see above table for details). Due to FCA accretion of USD 61 billion, RBI's income from FCA may have increased.
RBI did not give any specific reasons for the big increase in the surplus for last finanial year (see table above for data for the past 11 years). However, it will give the break-up of the its income and expenditure in its annual report for FY 2023-24, which is likely to be released in the next one week.
The main reasons for the record surplus could be:
a) Interest rates in the US (see Fed funds rate column in the above table) and other major developed economies have been higher in the past two years and RBI may have earned more income from its holdings of foreign currency assets (FCA). RBI deploys a major portion of its foreign assets abroad.
b) RBI may have earned higher gains from its foreign exchange trading as it undertakes purchase and sale of US dollars and Euros as part of its daily intervention to "smoothen excess volatility" in exchange rate. RBI uses both the US dollar and Euro as intervention currencies.
d) The increase in risk provisions RBI makes every year may have been flat in FY 2023-24.
3. What is CRB?
CRB is the component of RBI’s economic capital required to cover its monetary and financial stability, credit and operational risks.
Contingent risk buffer (CRB) is required to be maintained at between at 5.5-6.5 per cent of the RBI balance sheet size. The CRB is to be maintained by RBI at all times as per the August-2019 Bimal Jalan Committee recommendations, which were fully accepted by RBI.
Global rating agencies and investors look at a central bank and see whether it has a strong balance sheet.
CRB is necessary because as the country’s Monetary Authority and Lender of Last Resort, RBI has to ensure monetary, financial and external stability. RBI balance sheet needs to be resilient enough to absorb any external shocks.
As we have seen during the Global Financial Crisis (GFC) of 2008 / 2009, as an emerging market India is likely to face external shocks in the form of volatile capital flows, like, foreign investors selling Indian equities and debt.
Indian rupee may face challenges, like the 2013 Taper Tantrum by the US Federal Reserve, when Indian rupee depreciated by nearly 20 percent versus the US dollar in a short period of time -- though it recovered from its lows later.
CRB is the component of RBI’s economic capital required to cover its monetary and financial stability, credit and operational risks.
Contingent risk buffer (CRB) is required to be maintained at between at 5.5-6.5 per cent of the RBI balance sheet size. The CRB is to be maintained by RBI at all times as per the August-2019 Bimal Jalan Committee recommendations, which were fully accepted by RBI.
Global rating agencies and investors look at a central bank and see whether it has a strong balance sheet.
CRB is necessary because as the country’s Monetary Authority and Lender of Last Resort, RBI has to ensure monetary, financial and external stability. RBI balance sheet needs to be resilient enough to absorb any external shocks.
As we have seen during the Global Financial Crisis (GFC) of 2008 / 2009, as an emerging market India is likely to face external shocks in the form of volatile capital flows, like, foreign investors selling Indian equities and debt.
Indian rupee may face challenges, like the 2013 Taper Tantrum by the US Federal Reserve, when Indian rupee depreciated by nearly 20 percent versus the US dollar in a short period of time -- though it recovered from its lows later.
To manage such external vulnerabilities, RBI needs to have a robust stock of foreign assets.
RBI has to manage India’s foreign exchange reserves as well as rupee’s exchange rate volatility, in addition to being a monetary authority.
For the first time, RBI decided to maintain a CRB at 6.5 per cent for FY 2023-24, which is the higher bound of 5.5-6.5 per cent range recommended by the Bimal Jalan Committee.
RBI has to manage India’s foreign exchange reserves as well as rupee’s exchange rate volatility, in addition to being a monetary authority.
For the first time, RBI decided to maintain a CRB at 6.5 per cent for FY 2023-24, which is the higher bound of 5.5-6.5 per cent range recommended by the Bimal Jalan Committee.
Between financial years 2018-19 and 2021-22, RBI maintained CRB at the lower bound of 5.5 per cent (see above table), as India was facing fiscal challenges following COVID-19 Pandemic and draconian lockdowns imposed by Government of India.
The greater the CRB, the stronger the balance sheet of RBI.
The greater the CRB, the stronger the balance sheet of RBI.
4. What are Foreign Currency Assets?
Foreign currency assets (FCA) are part of India's foreign exchange reserves managed by RBI. Foreign exchange reserves include, FCA, gold holdings, special drawing rights (SDRs) and others.
RBI does not earn any income from gold, SDRs and others. But it earns income from FCA, which consist of multi-currency assets held in multi-currency portfolios.
Foreign currency assets (FCA) are part of India's foreign exchange reserves managed by RBI. Foreign exchange reserves include, FCA, gold holdings, special drawing rights (SDRs) and others.
RBI does not earn any income from gold, SDRs and others. But it earns income from FCA, which consist of multi-currency assets held in multi-currency portfolios.
As stated in Section 2 above, the value of FCA as at the end of FY 2023-24 is USD 571 billion, with an increase of USD 61 billion for the year (see above table).
Out of the total FCA, USD 469 billion are held in foreign securities (mostly sovereign debt instruments), USD 62 billion is with other central banks and Bank for International Settlements (BIS) and USD 40 billion is held as deposits with commercial banks abroad.
So, the level of FCA is an important variable for RBI to earn higher income. The higher the FCA, the higher the scope for earning greater returns (see above table for yearly data of FCA level and FCA accretion / depletion).
RBI maintains FCA in major currencies, such as, US dollar, Euro, British Pound, Japanese Yen and others, but FCA are expressed in US dollars.
Changes in RBI's FCA occur mainly due to:
a) daily purchase and sale of foreign exchange by RBI
b) income from foreign currency assets deployed abroad
c) external aid receipts of Government of India
d) changes on account of revaluation of assets
a) daily purchase and sale of foreign exchange by RBI
b) income from foreign currency assets deployed abroad
c) external aid receipts of Government of India
d) changes on account of revaluation of assets
5. What is Rate of Earnings?
Earnings (returns) from foreign currency assets (FCA) consist of interest, discount, exchange gain / loss and capital gain / loss on securities. Rate of earnings is earnings from FCA as a per cent of average FCA.
Earnings (returns) from foreign currency assets (FCA) consist of interest, discount, exchange gain / loss and capital gain / loss on securities. Rate of earnings is earnings from FCA as a per cent of average FCA.
As shown in the above table, you can compare how the rate of earnings has moved when the US Federal funds rate was lower and higher. As can be discerned, the higher the global interest rates (like the fed funds rate), the greater the rate of earnings.
When the global interest rates, like, the fed funds rate were lower, the rate of earnings on FCA used to be lower -- for example, in years between 2013-14 and 2017-18.
Prior to 2022, global central banks used to maintain ZIRP (zero interest rate policy), which pushed down the rate of earnings for RBI.
In
the past two years, global interest rates have been raised by the US
Fed and other major central banks and RBI is able to earn higher rate of
earnings on its FCA.
6. What are the implications for bond market?
As it is the Government of India is rolling in cash as it has been unable to spend its money due to prolonged schedule of Parliamentary elections under way in the country now.
As it is the Government of India is rolling in cash as it has been unable to spend its money due to prolonged schedule of Parliamentary elections under way in the country now.
During the current month, RBI unsuccessfully tried to buy back government securities three times from the market (for details, see here, here and here) to temporarily use government's surplus funds and reduce borrowing costs.
But the market was unwilling to accept lower yields offered by the RBI and hence RBI could only buy back a small portion of securities from the market.
RBI is Central Government's money manager.
In addition to existing higher government balances, the record RBI surplus transfer is a boost for central government's finances.
Government of India's balance sheet has been suffering from a very high fiscal deficit for the past four to five years. The record surplus may help in reducing India's fiscal deficit, which could give a boost to government bond prices.
Overall, these are good tidings for the bond market and we may see government bond yields heading lower in the immediate future.
The Union Government's forthcoming regular budget by the last week of June or the first week of July may give more colour on the topic.
Overall, these are good tidings for the bond market and we may see government bond yields heading lower in the immediate future.
The Union Government's forthcoming regular budget by the last week of June or the first week of July may give more colour on the topic.
7. How will the government use the record surplus?
In the past six years, PM Modi government has received Rs 6.60 lakh crore as RBI surplus transfer (since the Bimal Jalan Committee report).
In the past six years, PM Modi government has received Rs 6.60 lakh crore as RBI surplus transfer (since the Bimal Jalan Committee report).
What did they do with this huge money? Nobody knows clearly.
For several years, the government has stubbornly refused to lower fuel prices for consumers despite lower crude oil prices internationally. It has also not passed on the benefit of lower prices due to higher imports of cheaper Russian crude oil after the Russia-Ukraine war.
Consolidated Fund of India is a blackhole.
8. Recap
As global interest rates have been increasing in the past two years, RBI has been able to generate higher returns from its stock of foreign currency assets, which may have resulted in record surplus transfer by RBI to Government of India for the financial year 2023-24.
Overall, this is a positive for government bond market and bond yields may soften going forward, ceteris paribus.
But how the Government of India, which is notorious for its low State capacity and misallocation of resources, will spend the record surplus transfer is moot.
The Union Budget slated for the first week of next July may give some pointers.
(though the author started writing the blog yesterday, the article could only be completed on 24May2024 -- sorry for the delay!)
- - -
After the above blog was published on 23May2024, the following updates are added:
P.S. dated 09Jun2024: RBI provided the rate of earnings for FY 2023-24 in its annual report released on 30May2024. The rate of earnings on FCA for FY 2023-24 was 4.21 per cent.
In the exhibit below, you can compare columns 6 and 7: whenever there is an increase in global bond yields and interest rates (as represented by Fed funds rate), RBI's rate of earnings increases in general as can be seen in years 2023-24, 2022-23 and 2018-19.
The updated charts are given below:
Clarification on the above table:
Data in columns 2,3 and 7 (surplus transfer, CRB and rate of earnings) are as per RBI financial year (notes 3 and 4 in the table).
But data in columns 4, 5 and 6 (FCA year-end, FCA accretion / depletion and Fed funds rate) are as per Govt of India fiscal year that is, Apr-Mar for all the years.
Updated graph on rate of earnings:
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References and additional data:
Note 1: The media describes RBI surplus transfer as RBI dividend, which is a misnomer.
Note 2: The net income of RBI will be negatively impacted by a) rupee appreciation versus the dollar (nearly three-fourths of the RBI balance sheet is in forex reserves; so, stronger rupee leads to valuation losses for RBI); b) rise in cost of monetary operations under LAF; c) higher depreciation in rupee securities held by RBI; and d) any reduction in interest income due to decline in its portfolio size.
Forest trees silhouette - Pixabay
RBI press release 22May2024 - surplus transfer for FY 2023-24
RBI press release 26Aut2019 - surplus transfer for FY 2018-19
Bimal Jalan Committee report on ECF Aug2019 - the PDF
Half-Yearly Report on Foreign Exchange Reserves
Section 47 of the RBI Act, 1934 - RBI surplus transfer
RBI annual report 2018-19
RBI PR 19Nov2018 - decision to set up panel on ECF
Tweet 30Aug2019 - Rakesh Mohan interview on Bimal Jalan panel report
Tweet 26Aug2019 - Jalan report accepted
Tweet 27Dec2018 - RBI sets up Jalan panel on ECF
Tweet 31Oct2018 - clarification by Govt of India on RBI autonomy
Brief background to Bimal Jalan Committee:
Economic Survey of 2016-17 (released in Jan2017) made a dubious claim RBI had 'excess capital' to an extent of Rs 4 lakh crore and the same should be returned to Government of India. The Economic Survey 2016-17 was prepared when Arvind Subramanian was Chief Economic Advisor (CEA) and Arun Jaitley was India's finance minister.
This had set off a big debate in India and ultimately resulting in RBI acquiescing to Government of India's demands with the RBI deciding to set up a panel.
In Nov2018, RBI board decided to set up a panel on RBI's Economic Capital Framework (ECF) and accordingly a committee under the chairmanship of Bimal Jalan was set up by RBI in Dec2018.
After submission of the report, RBI fully accepted the recommendations of Bimal Jalan panel and transferred surplus in Aug2019 to Government of India as per Jalan panel formula.
Timeline of Bimal Jalan Committee on Economic Capital Framework (ECF):
Aug2024: RBI may have to review its ECF as per Aug2019 Jalan Committee report
27Aug2019: RBI releases Jalan Committee report
Aug2024: RBI may have to review its ECF as per Aug2019 Jalan Committee report
27Aug2019: RBI releases Jalan Committee report
26Aug2019: RBI accepts Jalan Committee report and transfers surplus
26Dec2018: RBI constitutes Bimal Jalan Committee on ECF
26Dec2018: RBI constitutes Bimal Jalan Committee on ECF
12Dec2018: Shaktikanta Das takes charge as RBI governor
11Dec2018: Urjit Patel resigns as RBI governor
19Nov2018: RBI board decides to set up ECF panel
Importance of RBI Revaluation Reserves (Revaluation Balances):
Revaluation reserves are the unrealized gains, net of losses resulting from exchange rate, gold price and interest rate movements, on account of periodic marking to market of Reserve Bank of India’s (RBI) foreign currency assets, gold, foreign dated securities and rupee securities (the Bimal Jalan panel reports uses the term, revaluation balances instead of the popular term 'revaluation reserves' -- the author prefers the popular term 'revaluation reserves').
Over the years, Indian rupee has depreciated against the US dollar and other major currencies. The depreciation has resulted in gains in RBI’s revaluation reserves.
Jalan panel recommended that revaluation reserves cannot be distributed to Government of India. Revaluation reserves arise from the revaluation of the foreign exchange reserves. The Jalan panel recommendations were fully accepted by the RBI.
As the rupee depreciates against the US dollar and other major currencies in which India’s foreign exchange reserves are held, the value of reserves increases in terms of rupee.
RBI’s balance sheet is expressed in rupees, hence the value of foreign exchange reserves also goes up during years of rupee depreciation – this is just an accounting entry.
In case the rupee appreciates against the US dollar and other currencies (currency risk), the revaluation reserves will come down. In calendar years 2017, 2010, 2009, 2007, 2004 and 2003, Indian rupee appreciated against the US dollar.
To be specific, in 2016–17, there was a sharp fall in the RBI’s revaluation balances due to a combination of Indian rupee strengthening against the US dollar and the fall in global debt yields.
The value of foreign currency assets (FCA) held by RBI too may come down due to market factors globally.
The biggest risk for RBI’s balance sheet is market risk, which arises from changes in prices of foreign securities, domestic securities and gold.
India’s foreign exchange reserves are subject to market risk, currency risk and liquidity risk. So, revaluation reserves work as a war chest to weather such risks. And as such, revaluation reserves cannot be distributed.
Unless RBI has some cushion in its balance sheet, it cannot face the challenges, if any, posed by turbulent markets. RBI needs the foreign currency assets during times of financial crises, if any. It needs a ‘rainy-day’ cushion.
Over the years, Indian rupee has depreciated against the US dollar and other major currencies. The depreciation has resulted in gains in RBI’s revaluation reserves.
Jalan panel recommended that revaluation reserves cannot be distributed to Government of India. Revaluation reserves arise from the revaluation of the foreign exchange reserves. The Jalan panel recommendations were fully accepted by the RBI.
As the rupee depreciates against the US dollar and other major currencies in which India’s foreign exchange reserves are held, the value of reserves increases in terms of rupee.
RBI’s balance sheet is expressed in rupees, hence the value of foreign exchange reserves also goes up during years of rupee depreciation – this is just an accounting entry.
In case the rupee appreciates against the US dollar and other currencies (currency risk), the revaluation reserves will come down. In calendar years 2017, 2010, 2009, 2007, 2004 and 2003, Indian rupee appreciated against the US dollar.
To be specific, in 2016–17, there was a sharp fall in the RBI’s revaluation balances due to a combination of Indian rupee strengthening against the US dollar and the fall in global debt yields.
The value of foreign currency assets (FCA) held by RBI too may come down due to market factors globally.
The biggest risk for RBI’s balance sheet is market risk, which arises from changes in prices of foreign securities, domestic securities and gold.
India’s foreign exchange reserves are subject to market risk, currency risk and liquidity risk. So, revaluation reserves work as a war chest to weather such risks. And as such, revaluation reserves cannot be distributed.
Unless RBI has some cushion in its balance sheet, it cannot face the challenges, if any, posed by turbulent markets. RBI needs the foreign currency assets during times of financial crises, if any. It needs a ‘rainy-day’ cushion.
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Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.
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