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RBI’s higher surplus transfer has limits

The Reserve Bank of India (RBI) released its annual report on Thursday, its first after a shift in the accounting year to April-March. This is a welcome change as it will align the central bank’s accounting year with that of the government and most of the private sector. Consequently, the latest annual report only covers nine months ended March 31, 2021. The RBI’s accounts were eagerly awaited by the financial markets as the announcement of a larger than expected surplus transfer (Rs 99,122 crore for nine months, compared to Rs 57,127.53 crore for the previous full year) to the government generated a fair amount of curiosity.

The central bank’s income declined by about 11 per cent during the year, but its expenditure went down by 63.10 per cent. The RBI’s balance sheet expanded by 6.99 per cent during the period under review, which reflected its liquidity and foreign exchange management interventions. It generated a higher than expected surplus on account of gains from foreign currency transactions (much of it in the last three months of the financial year) and lower provisions. Gains from foreign exchange transactions went up by 69 per cent to Rs 50,629.18 crore. While the central bank accumulated large reserves during the last fiscal year, which reached an all-time high of $590.3 billion in January 2021, it also sold a significant amount of foreign currency. A change in the accounting system allowed it to book gains on the sale of foreign currency against historical weighted-average cost.

A significantly higher surplus transfer in the middle of a pandemic when both tax and non-tax revenues are under pressure will help the government. However, there are some issues worth debating in this context. Government finances are likely to remain under pressure in the medium term. Thus, should the RBI be churning its foreign currency holdings to generate a surplus and ease the fiscal pressure? There are limits to the extent such gains can be generated. Additionally, would the RBI’s excessive focus on easing fiscal pressure not increase risks to financial stability? To be sure, the RBI has taken a number of steps to support the economy since the beginning of the Covid-19 pandemic. For instance, the monetary policy committee lowered the policy repo rate by 115 basis points last year. The RBI also conducted several longer-term repo operations to reduce friction in the financial system and boost liquidity, which helped bring down market interest rates.

However, the second wave of the pandemic has again increased uncertainty, and growth forecasts are being revised rapidly. The RBI has rightly noted that the pandemic is the biggest risk to the economic outlook. In the context of economic revival, the RBI notes that an increase in consumption and investment boosts output more in a downcycle than in an upcycle. Since capacity utilisation is low, the private sector is unlikely to invest. Thus, there is a need to push public investment to crowd in private investment. Private consumption can be supported by improvement in consumer credit. The government has budgeted for higher capital expenditure in the current year and should look for more resources to push spending. However, a durable recovery will depend on how quickly the pandemic is contained and a critical proportion of the population is vaccinated. It is also important for the government to have a clear exit strategy from fiscal accommodation as the economy recovers.

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