How does RBI makes money to pay huge dividends?

Introduction:

Under Section 47 of the RBI Act, 1934, after making provisions for bad and doubtful debts, depreciation in assets, contribution to staff and superannuation funds and for all matters for which provisions are to be made by or under the Act or that are usually provided by bankers, the balance of the profits of the Bank is required to be paid to the Central Government. And, under Section 48 of the RBI Act, 1934, the Reserve Bank is not liable to pay income tax or super tax on any of its income, profits or gains.

Here is a visual of the RBI’s dividend payout to Government over the years:

The dividend that Central Govt. received in FY21-22 is 69% lower than the amount it had received in the preceding period. This is largely due to substantial interest income that RBI has paid to commercial banks for the reverse repo operations conducted during the financial year for liquidity management, as banks have parked their surplus funds with the RBI. Alongside that, the decline in the forex reserves from the historic highs it had reached previously significantly contributed to the lower dividend.

But, the central question that comes to mind is – how does the RBI even generate the kind of income that enables it to pay such huge amounts of dividend to the central government?

Through the analysis of the RBI’s Income Statement, let’s see how….

Sources of RBI’s Income:

• Interest on holding of Rupee Securities (RS): Income under this line item consists of Interest earned on holding RS adjusted with Profit/Loss on sale and redemption, Depreciation and Amortization of RS. The RBI had earned ₹ 96,396.42 crores under this head in FY21-22 increasing by 61% from the previous period.
• Interest earned on LAF and MSF operations: Income under this line item consists of net interest earned on Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF). The income from head decreased from ₹(-)17,945.48 crore in 2020-21 to ₹(-)35,463.66 crore in 2021-22, decreasing by 97.6% due to higher surplus liquidity in the banking system leading to higher net interest outgo under LAF/MSF and current accounting year being of twelve months as compared to the nine months period for 2020-21.
• Interest earned on Loans & Advances: Income under this line item consists of interest income on loans and advances extended to Central and State Governments, banks and financial institutions and employees. The RBI had earned ₹ 1,501.82 crores under this head in FY21-22 decreasing by 12% from the previous period.
• Interest earned from Foreign Sources: Income under this line item consists of Interest Income from Foreign Currency Assets (FCA). The income from foreign sources increased by 98% from ₹ 80,715.82 crore in 2020-21 to ₹ 89,582.36 crore in 2021-22.

Expenditure incurred by RBI: The RBI incurs a major chunk of its earnings in making Risk Provisions. There are two risk provisions of the Reserve Bank, viz., Contingency Fund (CF) and Asset Development Fund (ADF). CF is a specific provision meant for meeting unforeseen and unexpected contingencies. The amount transferred to CF and ADF in FY21-22 was ₹ 1,14,567.01 crores and ₹ 100 crores respectively. The other charges incurred by the RBI is majorly for Printing of Notes, Agency charges and Employee costs.

The surplus amount that remains after the due adjustment of the expenditures with the income earned by the RBI, is transferred to the Central Govt. as dividend, which in FY21-22 was ₹ 30,307.45 crore.

Providing the huge dividend payouts to the government requires the RBI to devise methods of earning greater income as well. The most popular methods employed by it is as mentioned below:

• Seigniorage:

The RBI makes money through what is called Seigniorage. Seigniorage refers to the profit made by a government from minting currency. Seigniorage is determined by the difference between the face value of the currency and the cost of producing it.

This means that when it prints rupees to buy government bonds, the printing cost is negligible. As a result, the entire incremental bond portfolio becomes income.

While the RBI does not calculate Seigniorage income, the surplus transferred to the Government is substantially more than the Seigniorage income, given that the transfers to the Government over the last 5, 10 and 20 years have been 90 per cent, 74 per cent and 66 per cent, respectively, which is higher than what the RBI’s Seigniorage income would be.

• Forex Operations:

In 2019, the Jalan Committee recommended to the RBI that, when it sells dollars, it may use the historical average price at which it acquired dollars as the purchase price, subtract it from the price at which it sold dollars in the current year, and pay the difference to the government as a dividend. While this formula cannot be faulted, if the RBI wants to declare a higher dividend, it can do a slew of sell-buy swaps and “account” for a higher dividend to the government. From the below table, it may be noticed that in 20-21, RBI has bought at least twice the amount of dollars it did in 2019-20; and sold over 3 times what it did in 2019-20, recording a steep jump in figures in FY21.

It is tempting to conclude that, in response to a demand for a higher dividend, the RBI went down this path of selling spot dollars and buying forward in order to “book” profit on dollar sales and thus account for a higher dividend.

Conclusion:

The dividend transfer by the RBI constitutes an important element which is considered by the Central Govt. in the arriving at overall budget provisions for the fiscal year. It is one of the major sources of funding for the Govt. alongside its revenue collections.