RBI's bonanza to the government

In today's Finshots we talk about why the RBI decided to transfer 99,122 crores as dividends to the government for a period of just 9 months

The Story

Before we get to the nitty-gritty perhaps it's prudent to ask—"How on earth did the RBI accumulate this much money?"

Well, it’s complicated, but perhaps you can think of it this way. The Reserve Bank of India routinely prints new money as part of its daily operations. A popular use case is the RBI’s intervention in the open market where it continues to scoop up government bonds. It’s sort of like the RBI trying to lend money to the government, albeit indirectly. And this magnanimity, in turn, helps the state borrow money at relatively low-interest rates. It’s something that they do quite often. But bear in mind, the government is still liable to return every single penny with a little extra cash on top. And when they do, the RBI can make a small profit.

Outside of this, the RBI can also use its freshly minted money to buy foreign currency. When the value of said foreign currency appreciates, the RBI can choose to sell them in the open market and make a tidy profit once again. And while we could go on and list more use cases, we hope the basic premise is evident by now. RBI can print money at a ridiculously low cost and then make more money out of it. And as their profits/reserves build up, they can choose to part with it, by transferring a sizeable sum to the government — if they believe such an exercise might bear fruit.

Sure, they’ll still set aside a small part of their reserves for a rainy day, but they have a pretty good idea on the kind of money they can choose to part with. So these transfers shouldn’t come as a surprise. However, at this point, you’re probably wondering — Why not just keep doing this more often? Perhaps aid the government with financial resources at a time of crisis.

Well, they could do it. But pay close attention to the sequence of events here. The RBI was buying government bonds and foreign currency in an attempt to foster economic and financial stability. They weren’t doing it because they wanted to make money. In fact, any central bank that can print its own currency can theoretically transfer large sums of money to the government without having to go through the pain of accumulating and apportioning reserves. But they don’t do it because this money has the potential to enter the real economy and wreak havoc. Think Inflation or worse, Hyper Inflation.

Bottom line — The profits simply accumulated because the RBI was trying to fulfill its mandate. They were hoping to ensure price stability in a bid to promote long-term economic growth. And while they managed to accumulate a sizeable reserve in the process, this was never the primary motivation.

However, transferring nearly 1 lakh crores to the government does seem a bit excessive. So should anyone be worried?

Well, perhaps not. Everything in life carries with it a certain amount of risk. When you visit the grocery store next door, there’s a tiny possibility that a turtle might snap at your heels and incapacitate you. The probability is low, but it’s not zero. So does that mean you stop visiting the grocery store altogether? Of course not! You weigh the risks and rewards and make a prudent choice afterwards. Right now, the government has an overwhelming debt burden, a whole host of unproductive public sector assets, a hefty expenditure bill (thanks to Covid) and very little money to spare. If they don’t manage to prop up the economy, we could be looking at massive economic contractions. They need to spend and spend well. But if they’re cash strapped, any possible intervention might not yield the intended consequences.

So that’s what the RBI is dealing with here — “They could choose to apportion a higher share of the reserves and see what happens, or they could withhold a large chunk of the profits and let the government deal with the fallout on its own”

And since everybody would agree that this is no time for caution, the central bank was perhaps fairly comfortable transferring such a large surplus to the government.

Anyway, that’s it from us today. We will see you tomorrow. Until then, don't forget to share this article on WhatsApp, LinkedIn and Twitter