High liquidity shrinks RBI surplus

Rupee appreciation hits returns on RBI’s foreign assets; high printing cost of new currency notes also makes a dent

Abundant liquidity postdemonetisation with banks and resultant reverse repo measures by the Reserve Bank of India as well as cost of printing new currency notes will result in fall in the central bank's transfer of surplus to the union government this financial year, almost half of what was given in 2016-17.

The strengthening of the rupee against the dollar also pulled down the value assets owned by RBI overseas.

The RBI said it would transfer ~30,659 as surplus to the government in 2017-18, much lower than last year’s ~65,876 crore. The Union Budget for 2017-18 projected receipts of ~75,000 crore from the RBI, public sector banks and financial institutions, against a little over ~76,000 cr in 2016-17. Of this, public sector banks and financial institutions are expected to chip in ~10,000 crore.

The Union government’s fiscal deficit target could be jeopardised by lower dividends and any cutbacks in capital expenditure will hurt the government efforts to revive the investment momentum.

Devendra Pant, chief economist with India Ratings says RBI paid interest to banks for soaking surplus liquidity with them, through its reverse repo operations.

"So, instead of RBI getting money from repo operations, it gives interest rate to banks through reverse repo," he explained.

Reverse repo currently stands at 5.75 per cent.

RBI which soaked just ~3,484 crore on the day demonetisation was announced on November 8, 2016, absorbed as high as ~51,900 crore on December 13, to cite an instance.

"Higher costs associated with liquidity absorption is likely to be one of the primary factors squeezing the surplus from the RBI to the government," says Aditi Nayar, principal economist with ICRA.

Cost of printing comes to about ~2.5 for new 500 currency notes a piece and ~3.50 for new 2,000 notes a piece, experts say.

Pant also says that stronger rupee against the dollar shrank the value of foreign assets that RBI had. RBI keeps its foreign assets mainly in US treasury bonds and gold.

Rupee appreciated by 4.7 per cent from average value of ~67.65 in November, 2016 to ~64.45 in July (last month of RBI's financial year).

The RBI is yet to count the rupee that has come back to the system out of over ~15 lakh crore of old ~500 and ~1,000 that were in circulation.

Once it is over, it would be known how much liabilities it will extinguish and how much transfer would come to the union government. But, this may come only next financial year, after the RBI's financial year ends in June, 2018.

Madan Sabnavis, chief economist with CARE Ratings, says the ~35,000 crore decline in dividend from the RBI constituted 0.2 per cent of the GDP and this development could widen the fiscal deficit from 3.2 per cent to 3.4 per cent in 2017-18.

The Centre's fiscal deficit in the first quarter has reached 80.8 per cent of the target for 2017-18. The figure was 61.1 per cent in the corresponding period of the previous fiscal year.

Sabnavis says the axe might fall on capital expenditure if the fiscal deficit target was to be met.

India's economic growth is projected to decline to 6.75-7.5 per cent in 2017-18 from 7.1 per cent in 2016-17. The government has presented a medium term framework of expenditure that shows capex rising 10 per cent in three years, starting in 2017-18.

Nayar says the smaller dividend from the RBI would need to be offset through higher tax revenue because surpassing the budgeted disinvestment target would pose a challenge.

"The pattern of monthly tax revenue growth may display some change in the months immediately after the introduction of the GST on July 1," she added.

Pant says direct tax collections could provide some buffer to the Centre. Direct tax receipts in the first four months of 2017-18 were 19.1 per cent higher as refunds declined even as the gross amount paid by companies reflected their struggle with the GST.

Ranen Banerjee, partner with PwC, does not agree that a cut in capex would hurt economic growth. He says capex was generally overestimated. Also leakages in subsidy payouts were being plugged through cash transfers, he added.