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India Strategy: RBI reserve bonanza - Fiscal space for increased expenditure emerges

RBI’s board decided to transfer a sum of Rs1.76trn to the central government for FY19 – a) Rs1.23trn would comprise of regular profit transfer and b) Rs526bn would be excess realized equity reserves (which going forward would be limited to 5.5-6.5% of RBI’s balance sheet). Our calculations indicate that the government will receive Rs580bn in excess of Rs900bn it accounted for as transfer from RBI in ongoing fiscal (FY20). This would mean a scope of expenditure expansion worth 2.5% on overall actual expenditure by the central government in FY19. Consequently, with a multiplier effect into play, we now expect governments overall expenditure growth to outdo GDP growth in FY20, thus providing impetus to otherwise soft economic growth. Combined with ongoing monetary stimulus and other growth supportive announcements, we believe there is enough to help growth recover.

Event: RBI’s board has decided to transfer a sum Rs1.76trn as a dividend for FY19. This amount comprises of two key components: a) Transfer of RBI’s net income in FY19 (Rs1.23trn) and b) transfer of Rs526bn from RBI’s reserve based on new revised Economic Capital Framework (ECF), which was finalized by expert committee chaired by ex-RBI governor Dr. Bimal Jalan, in last few months. RBI has already transferred Rs280bn as interim dividend for FY19, hence remaining Rs1.48trn would be transferred by RBI, which the government will count towards FY20 revenue for the central government.

Underlying calculation: Bimal Jalan committee deliberated upon appropriation of two key reserves segments on RBI’s balance sheet: a) revaluation reserve and b) contingency reserve or realized equity reserve (details ). Committee clearly states that revaluation reserves are unrealized valuation gains and cannot be distributed. Hence they focus on the other segment of reserves – realized equity (aka contingency reserve), which is built up from retained earnings and hence is distributable. Committee also determined the comfortable level of reserve would be at 5.5-6.5% of RBI’s balance sheet. As of FY19, RBI’s realized equity stood at 6.8% of balance sheet and a decision to limit realized equity to 5.5% for now was taken. This rendered Rs526bn free for transfer to government as an additional surplus. Also, the recommendation of holding 5.5-6.5% of total asset as economic capital is higher than 2% global average indicated by the study.

Fiscal Impact: Government had accounted for ~Rs900bn as dividend from RBI in FY20. Adjusting for Rs280bn paid as interim dividend, RBI will transfer Rs954bn to the government (Rs54bn higher than what was accounted earlier). Transfer of Rs526bn was not accounted for in the budget as well and thus creates an additional fiscal space. These two components together create an additional spending capacity (over and above what’s budgeted) of Rs580bn for FY20.

Also, payout of special dividend (Rs526bn) by the RBI will be used by GoI to retire existing debt, which will be followed by reissuance of equivalent debt in the market (placed with banks or through regular auctions). In our view, since the Government has already provided Rs 700bn as PSB recapitalization bond, the reserve transfer will be entirely utilized for funding fiscal spending

Does this move the needle? Cumulative measures are reasonably stimulative

Reserve transfer of Rs 580 bn is roughly around 0.27% of GDP, which can cover a potential slippage in fiscal deficit to GDP to same extent over and above the budgeted 3.3% for FY20. In terms of growth in government spending, it enhances spending growth by 2.5 percentage point over our expectation of 15% vs the budgeted 20.5% for FY20 (or Rs 27.8tn). Enhancement of 2.5 percentage point in total spending (we assume it to be consumption spending) will create a fiscal multiplier of 1.5 time or 3.8 percentage point over the next 4 quarters. Also, since we expect the RBI to monetize the issuance of fresh Gsec, the money multiplier of this increase in reserve money supply will be Rs 2.9tn (current money multiplier of broad money M2 to reserve money M0 is 5.5x). Hence, considering both the fiscal and money multiplier impacts, there is a reasonable support that can imply from this reserve transfer.

Overall, considering the totality of measures taken by the government and RBI including monetary stimulus, front loading of PSB recapitalization, regulatory relaxation for NBFC on-lending, intent to clear government payment backlogs, GST refunds and focus on sectors such as MSME, Housing and Agriculture, we believe there is a reasonably good demand stimulus that has been put in place. This should play out over the next 4 quarters. In addition, finance minister has promised additional measures with respect to housing and global trade

 Jalan committee recos conserves RBI’s independence: The fact that the Jalan committee has recommended transfer of surplus reserve from Contingency reserve alone and leave the Fx revaluation reserve unchanged is most appropriate, according to us. It is in contrast with earlier suggestion by Arvind Subramanian et al (Study: Paranoia or prudence? How much capital is enough for RBI?, EPW Dec 2018), who suggested that the revaluation reserve should also be used for paying special dividend to GoI. The committee approach ensures independence of RBI’s monetary policy and its currency management operations.

Minimum buffer norms are moderately stringent: The Expected Shortfall (ES) model used for calculating Value at Risk (VAR with 99.5% confidence interval) is a mid-level framework between a liberal simple VAR estimate and a stringent S-VAR estimate capturing restricted sample of very high volatility event in the past. ES model estimates the capital buffer based on all adverse events over the history of the sample period. Hence, the ES framework is moderately stringent. The accepted level takes the lower bond i.e 5.5% of total asset implying a surplus of 1.3 percentage point against the actual of 6.8%. This ensure that the transfer of Reserve of Rs 53.64 bn is the maximum within the limits recommended by the Jalan Committee.