RBI declared a hefty dividend: What does it mean?

The Reserve Bank of India (RBI) has declared a hefty dividend for FY24, and it is the talk of the town as it is way above the analysts' and government's projections. What does it mean for the government and the Indian economy? In this article, we answer these questions and try to understand the role of RBI in the economy.

What is the role of RBI in Indian Economy?

RBI is the central bank of India, and it plays a critical role in the country's economic health. It has multiple functions related to the Indian economy. Some of them are:

• Monetary Policy: The RBI controls the money supply and interest rates in India. It helps manage inflation, which is the rise in prices of goods and services. By adjusting these factors, the central bank aims to achieve price stability and promote economic growth.
• Issuing Currency: The RBI is responsible for printing and managing the circulation of Indian rupees. It ensures the availability of clean and genuine banknotes and combats counterfeiting.
• Banking Regulation: The RBI supervises and regulates commercial banks and financial institutions in India. The central bank ensures the smooth functioning of the banking system and protects depositors' interests.
• Financial Stability: It works to maintain financial stability by managing foreign exchange reserves, overseeing credit risks, and implementing regulations to prevent financial crises.
• Development Role: The RBI also plays a developmental role by promoting financial inclusion, providing financial literacy, and supporting the development of the financial sector in India.

How does RBI earn revenue?

The first thing we need to understand is how it earns revenue. Once we do, it would be easy to learn how RBI declares a dividend for the government.

In the next section, we look at the exact details of RBI investments that make them earn revenue. Here, we look at all the revenue options of RBI at a high level:

• Lending to Banks: The RBI lends money to commercial banks at a specific interest rate. It is a major source of income for the RBI.
• Government Bonds: The RBI purchases government bonds, which earn interest payments from the government.
• Foreign Investments: The RBI invests a significant portion of its foreign exchange reserves in assets like US treasury bonds. These investments generate interest income.
• Foreign Exchange Operations: The RBI manages India's foreign exchange reserves. By buying and selling foreign currencies like dollars, the RBI can make a gain if the exchange rate fluctuates favorably. For instance, if they buy dollars at a low rate and then sell them at a higher rate, they earn a profit on the difference.
• Other Income: The RBI also earns income from fees associated with various services, such as currency management and banking supervision.

History of Dividends declared by RBI in India

To understand why the RBI dividend declaration is in the news this time around, we need to look at the dividend history declared by RBI in India. Here is the dividend history from the last few financial years:

Current high-income yielding investments by RBI

In this section, we look at specific investments made by the RBI, which helped them declare much higher dividends compared to previous financial years. 

First, if we look at RBI data, we will see an increase in the bank's foreign currency reserves by $61 billion from $509 billion to $570 billion (or Rs 47.2 lakh crore). Per experts, the central bank would have earned around 3% returns on this investment. It makes the interest as Rs 1.42 lakh crore.

The second source of earnings for the central bank was the selling of dollars. As per the data, RBI sold $153 billion in FY24. 

The key point is that when the RBI sells US dollars, it calculates its purchase price as the average price of all dollars bought historically. As per economists, the historical price was probably around Rs 75–76 per dollar. They would have sold the dollars at least at Rs 83/dollar. So effectively, RBI made a profit of Rs 8 on every dollar sold in this period. It means that with the sale of $153 billion in FY24, the central bank probably made revenues of Rs 1.2 lakh crore.

The RBI would have made a packet of Rs 0.8-1 lakh crore on interest earned on its Indian government bond holdings of Rs 13.5 - 14 lakh crore in FY24. The RBI would have put in some losses on its books as it would have lost some revenue on its domestic market operations since it was absorbing money for 259 of the 365 days in FY24.

Dividend Announced for FY24

The total dividend announced for FY24 by RBI is Rs 2.1 lakh crore, much higher than the government expectation of Rs 1.02 lakh crore, which it kept in the budget. It is essential to mention that some central banks in advanced economies have reported losses and negative equity. As per experts, the stellar performance of RBI in this area is a result of RBI's active intervention in foreign exchange and money markets.

How will this dividend help GOI?

Let us look at how this highest-ever dividend will help the Indian government:

Reduced Fiscal Deficit: The dividend can help the GOI narrow its fiscal deficit, which is the gap between its expenditure and revenue. A lower deficit improves the government's financial stability and creditworthiness, potentially reducing borrowing costs.

Increased Spending: The additional income can provide the government with more resources to allocate towards social welfare programs like education, healthcare, and poverty alleviation. It can also be directed towards infrastructure development projects like roads, bridges, and public transportation, which can boost long-term economic growth.

Lower Borrowing Needs: The RBI's dividend can reduce the government's need to borrow funds through issuing bonds. It can lead to lower interest rate payments and free up resources for other priorities.

Way forward

In the coming financial years, RBI's ability to generate similar profits and pay similar dividends will be limited. Why is that so? We have talked about it earlier, but let us re-iterate. Whenever RBI makes significant dollar purchases(as in FY24), the average dollar costs in its reserves increase. With the dollar around 83 now, the average cost will rise from 78 to 80 (probably). Therefore, unless the rupee depreciates further this year, it would be difficult for the central bank to record comparable gains and dividends for the current financial year.

Before you go

A healthy RBI dividend will be seen as a sign of a strong and stable economy, potentially improving investor confidence in India. It can lead to increased investments and economic activity.