Why does RBI transfer dividends to the government?
The Reserve Bank of India (RBI) holds a critical position in India’s financial architecture, not only steering the country’s monetary policy but also significantly impacting the government’s fiscal framework. One of the important tools that govern this interplay between the central bank and the government is the Economic Capital Framework (ECF). This mechanism establishes the guidelines for RBI’s risk provisioning and the transfer of surplus or dividends to the government. The Economic Capital Framework was formally adopted by the RBI in 2019 following recommendations by the Bimal Jalan Committee in 2018. The ECF serves as a structured approach to determining the appropriate levels of risk provisions and the surplus that the RBI can transfer to the government as mandated under Section 47 of the RBI Act, 1934.
At the core of the ECF is the Contingency Risk Buffer (CRB), which acts as a financial safety net maintained between 5.5% and 6.5% of the RBI’s balance sheet. The CRB safeguards the RBI’s capacity to function as the lender of last resort during periods of financial distress. If the RBI’s realized equity, which includes the contingency fund, exceeds this stipulated range, the excess amount is transferred to the government. Additionally, the framework requires the RBI to maintain its Economic Capital, comprising capital, reserves, risk provisions, and revaluation balances such as those arising from fluctuations in exchange rates, gold prices, and interest rates, within the range of 20.8% to 25.4% of the balance sheet. Any surplus beyond this range can also be transferred to the government. The evolution of this framework has been shaped by various expert committees over the years. The ECF is subject to a review every five years to ensure it remains aligned with changing economic conditions, with the latest review conducted in August 2024 reaffirming the existing parameters.
In recent years, there has been a marked increase in the dividend transferred by the RBI to the government. For instance, the transfer stood at INR 30,307 crore in the financial year 2022 but is estimated to surge to between INR 2.5 lakh crore and INR 3 lakh crore by 2025. This substantial rise is primarily due to the RBI’s strong earnings from foreign exchange operations, including dollar sales, gains from rising gold prices, and appreciation in government securities. The increasing size of the RBI’s balance sheet has also played a role in this upward trend. The larger dividend payout is expected to provide significant fiscal support to the government, particularly in the backdrop of the fiscal deficit target set at 5.1% of GDP for 2024–25.
The significance of the RBI’s surplus transfer to the government cannot be overstated. It helps reduce the fiscal deficit by augmenting non-tax revenues, thereby easing the government’s borrowing requirements. This, in turn, lowers government borrowing costs by softening yields on government securities, which also has the effect of reducing the debt servicing burden. Additionally, lower sovereign yields tend to influence broader market interest rates, making borrowing cheaper for businesses and households, which can stimulate economic activity. The surplus transfer also helps enhance the government’s capacity to finance public expenditure, including capital investments critical for growth and development.
While the ECF and the associated surplus transfer have considerable benefits, some concerns persist. One such concern is the potential impact on the RBI’s autonomy if the central bank is pressured to transfer higher dividends to meet fiscal needs. There is also the risk that depleting the RBI’s risk buffers may reduce its ability to respond effectively to future economic shocks. Moreover, large and frequent surplus transfers might send mixed signals to the markets about the independence and financial strength of the RBI, potentially affecting investor confidence.
