RBI’s Surplus Transfer providing Multiple Options to drive India’s Economic Growth!

What’s the Point?

The Central Board of the Reserve Bank of India (RBI) approved the transfer of ~₹2.11 lakh crore as surplus to the Central Government for FY2024, which is more than double the Government’s budgeted dividends from RBI, nationalised banks and financial institutions of ₹1.02 lakh crore (Budgeted amount of ~₹85,000 crore from RBI). With the macroeconomic conditions witnessing a strong improvement in the past 2-3 years, the Board has been steadily increasing the Contingent Risk Buffer (CRB) – the country’s savings for a financial stability crisis – to the upper limit of 6.5% of RBI’s Balance Sheet for FY2024 from 5.5% for FY2022 and 6% for FY2023. This record transfer could act as a great positive for India’s structural growth because it provides the Government with the options of a faster pace of fiscal consolidation and / or higher capital or revenue expenditure.

Numbers in Perspective

Source: Centre for Monitoring Indian Economy (CMIE), RBI, Bloomberg

How does RBI generate revenue?

RBI generates revenue from various sources like (a) earnings from Foreign Currency Assets (FCA), (b) earnings from holding Rupee Securities and discounted instruments, (c) Interest on Liquidity Adjustment Facility (LAF) / Marginal Standing Facility (MSF) / Standing Deposit Facility (SDF), (d) Interest on other loans and advances. Of these, a major source – nearly 65% of the RBI’s Total Earnings as per RBI’s FY2023 Annual Report – came from Foreign Currency Assets (~₹1.52 lakh crore as on March 31, 2023), a component of India’s Gross Foreign Exchange (FX) Reserves.

Drivers of the Transfer of Record Surplus of ₹2.11 lakh crore

• Recently, RBI’s weekly statistical supplement revealed that India’s FX reserves surged to an all-time high of $648.7 billion (as on May 17, 2024). Of this $648.7 billion, ~88% of these reserves are FCA. While FCA include investments in various assets, the biggest percentage of the RBI's income came from investments in US bonds and treasuries. India’s FCA has risen by ~$61 billion in FY2024 to ~$571 billion. With the interest rates in US being higher in FY2024 across the yield curve, the increase in interest income from India’s FCA could have been one of the biggest drivers of the surplus transfer of ₹2.11 lakh crore in FY2024.
• Another component of the income came from the sales of US Dollars ($) by RBI. In FY2024, RBI sold US Dollars ($) worth $153 billion of its FX reserves, which was 28% lower than $212.6 billon sold in FY2023. While the profit generated from this FX sales is less than FY2023, it could have contributed to this transfer of surplus.

Multiple Options – All Winners! What action should the Government take?

On account of larger than expected surplus transfer from RBI, the Government has now received an additional revenue of ~₹1.26 lakh crore this year – 0.38% of the GDP (Source: Nomura). As a result, the Government has multiple options for channelling this additional revenue:

1. The Government has remained focused on stepping up its capex for aiding the development of India’s multi-modal infrastructure and large-scale manufacturing facilities in India. While it has announced a budgeted allocation ₹11.11 lakh crore – 16.9% higher than the FY2024 Revised Estimates in the Interim Budget 2024-25, this surplus could be used to boost Government spending.
2. The additional revenue gives the Government an option to allocate an amount for higher welfare spending like subsidies provided by the Central Government – particularly food subsidies and other welfare schemes like Mahatma Gandhi National Rural Employment Guarantee Programme (MGNREGS). While rural consumption has outpaced urban consumption growth for the first time in 15 months – at 7.6% vs 5.7% for urban (Please read: HDFC Mutual Fund's Tuesday's Talking Point - Rural consumption growth presents an opportunity!), the growth in rural consumption has historically lagged the growth in urban consumption. Hence, a higher allocation could support the growth in rural consumption.
3. The Government could utilize the whole additional revenue of ₹1.26 lakh crore to reduce the FY2025 Gross Fiscal Deficit (GFD) to ₹15.54 lakh crore from the budgeted ₹16.8 lakh crore (Interim Budget 2024-25). This implies a reduction of GFD to GDP ratio from a budgeted 5.1% for FY2025 to 4.7% of the GDP during F2025. This step will align well with the Government’s commitment of bringing down fiscal deficit to less than 4.5% of GDP by FY2026. A reduction in the fiscal deficit could lead to lower than expected government borrowings, and moderation in yields. It is notable that the yield of Indian 10-year Government Bond has been on a downward trajectory in May – trading below 7% on 27th and 28th May 2024.

The Government has the responsibility of driving economic growth while maintaining fiscal prudence. Thus, keeping the aforementioned options in mind, the Government could utilize the additional revenue for a mix of all the 3 options.

Sources: CMIE, RBI, Bloomberg, Nomura, Citi Research, and other publicly available information

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