Why in the News?

Recently, the RBI announced that its central board had held its 615^th meeting and that it had reviewed the Economic Capital Framework (ECF).

What’s in Today’s Article?

• About ECF (Introduction, Key Features, etc.)
• Review of ECF (Current Review, Govt Involvement, Dividend Transfers, Implications, Challenges, etc.)

Introduction

• India’s central bank, the Reserve Bank of India (RBI), is undergoing a crucial review of its Economic Capital Framework (ECF), a policy instrument that governs the risk provisioning norms and surplus distribution to the government.
• With the Finance Ministry concurrently conducting a parallel review, the outcome could determine the scale of dividend payouts to the government, particularly at a time when higher public spending, especially on defence, is on the cards.

Understanding the Economic Capital Framework (ECF)

• The Economic Capital Framework was introduced in 2019 following the recommendations of a committee chaired by former RBI Governor Bimal Jalan.
• It defines the level of risk provisioning the RBI must maintain, mainly through the Contingency Risk Buffer (CRB), before transferring any surplus to the government.
• Key Features:
  • Contingency Risk Buffer (CRB): A safety buffer against financial instability, recommended to be in the range of 5.5% to 6.5% of the RBI’s balance sheet.
  • Surplus Transfer Mechanism: Once CRB requirements are met, any excess can be transferred as a dividend to the government.
  • Five-Year Review Cycle: The Jalan committee had recommended that the ECF be reviewed every five years.

Current Review and Government Involvement

• Since January 2025, RBI officials have been internally reviewing the ECF, while the Ministry of Finance has initiated a parallel review process.
• Government officials have expressed the view that the existing buffer range may be too conservative, hinting at the possibility of reducing the CRB to allow for higher transfers.
• A senior government official indicated that even with a hike in defence spending, the government is not fiscally constrained. However, a higher surplus from the RBI would certainly offer greater fiscal headroom.

Record Dividend Transfers and Projections

• In 2023-24, the RBI transferred a record ₹2.11 lakh crore as surplus to the government, significantly higher than ₹87,416 crore in 2022-23.
• For FY 2024-25, the surplus transfer is projected to be between ₹2.5 lakh crore and ₹3 lakh crore, a new potential record.
• Factors Contributing to Higher Earnings in FY25:
  • Profits from the sale of U.S. dollars to stabilize the rupee.
  • Appreciation in gold prices.
  • Gains from government securities held by the RBI.
• The RBI’s contingency provisioning in FY24 stood at approximately ₹42,800 crore. The central board of the RBI is scheduled to meet on May 23 to finalize the dividend transfer for FY25.

Implications of a Higher Dividend

• A larger surplus transfer will help the government in multiple ways:
  • Managing Fiscal Deficit: Higher dividends will ease fiscal pressure and reduce the need for additional borrowing.
  • Improved Liquidity: Increased liquidity from the surplus may positively impact the banking system. According to a report by Axis Mutual Fund, the expected banking liquidity post-dividend could reach ₹6 lakh crore.
  • Political and Budgetary Support: With elections approaching and defence needs rising, the government is expected to use such fiscal flexibility strategically.

Challenges and Cautions

• While higher transfers are welcome from a fiscal standpoint, concerns remain about diluting the RBI’s financial safety net.
• The CRB serves as a buffer during times of economic instability, and any reduction could limit the RBI’s capacity to manage systemic shocks effectively.
• Balancing financial stability with fiscal needs will be crucial in the final decision.

Conclusion

The RBI’s ongoing review of the Economic Capital Framework, alongside the Finance Ministry’s own assessment, marks an important moment in the fiscal relationship between the central bank and the government.

As the RBI prepares to announce the dividend for FY25, the decision could redefine surplus transfer norms and shape India’s fiscal trajectory in a crucial pre-election year.