Context: The Surplus available with the Reserve Bank of India for transfer or the RBI dividend to the Union government is likely to remain low in the current financial year ending March 2023 because of higher expenditure incurred by the central bank due to rising interest rates and higher costs in managing surplus liquidity in the system.
What is RBI dividend? Why does the RBI pay a dividend to Government?
- As the manager of Government finances, every year, the RBI pays a dividend to Government to help with the Government’s finances from its surplus profit. The RBI was founded in 1934 and has been operating according to the Reserve Bank of India Act of 1934. Chapter 4, section 47 of the Act, titled “Allocation of Surplus funds” mandates for any profits made by the RBI from its operations to be sent to the Centre.
- Under Section 47 of the RBI Act, “after making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation funds 2 [and for all other matters for which provision is to be made by or under this Act or which] are usually provided for by bankers, the balance of the profits shall be paid to the Central Government.”
- It is according to this Act, the RBI pays dividend to the government from its surplus profits.
How does the RBI earn its profit?
- The RBI earns money in a variety of ways. Open market operations, wherein a central bank purchases or sells bonds in the open market in order to regulate money supply in the economy, are a major source of income for the RBI. Apart from the interest received from these bonds, the RBI may also profit from favourable changes in bond prices.
- Dealings in the foreign exchange market that the RBI engages in may also contribute to the bank’s profits. The RBI, for instance, may buy dollars cheaply and sell them dear in the future to pocket profits.
- However, that unlike commercial banks, the primary mandate of the RBI is not to earn profits but to preserve the value of the rupee. Profit and loss are thus merely a side effect of its regular operations to shape monetary policy.
Why RBI pays lower dividend?
- Several aspects affect the quantum of surplus generated by the RBI.
- Interest rate the central bank must pay when banks park their funds with the RBI (Reverse Repo Rate)
- Rupee depreciation against dollar.
- As bond prices dropped with rising yields, RBI had to provide for mark-to-market losses.
- Interest Rate – Under reverse repo, the RBI borrows from banks, while under the repo window, RBI lends to banks. The reverse repo rate is 3.35 per cent and the repo rate is 6.25 per cent. The lower dividend could be due to higher interest payments to banks which parked their surplus liquidity in the reverse repo window.
- Rupee Depreciation against Dollar – The Indian Rupee has depreciated nearly 10 per cent this year so far, breaching the key sentiment level of 82 against the US dollar for the first time in history.
- Drop in Bond Prices – Bond yields had risen further since then in most overseas markets with the 10-year US bond yield rising by 185 basis points to 3.59 per cent in the last 12-month period. When the yield goes up, the prices of the bond drop, leading to a loss in mark-to-market holdings.