The Sholay Redux: Will RBI give Modi govt’s Budget a happy ending?

The RBI may temporarily come to the government’s rescue with a much higher dividend than it should give, nevertheless, that will come with its own cost.

WrittenBy:Vivek Kaul
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Haan jab tak hai jaan, jaane jahan, main nachungi,” sings Basanti, towards the end of the cult classic Sholay.


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The hands of Veeru, Basanti’s boyfriend, up until then, are tied. The villain, the menacing looking khaini chewing Gabbar Singh, is ready to kill him, but as long as Basanti dances, Veeru will stay alive. The audience watching the movie is slightly nervous, but it knows that Veeru’s friend Jai will come to the rescue and they will live happily ever after.

Dear Reader, you must be wondering what has Sholay got to do with a piece which has the words, RBI, Government and Budget, in the headline. Allow me to explain.

Nirmala Sitharaman, India’s first full-time female finance minister, presented the first Budget of Modi government 2.0 yesterday. Unlike, other finance ministers before her, Sitharaman in her speech talked about everything but the Budget—which basically refers to the government’s expenditures on various things during this financial year, and where the earnings to finance those expenditures are likely to come from. But just because she did not discuss the numbers, doesn’t mean we shouldn’t either.

The central government earns a bulk of its earnings from corporation tax (income tax paid by corporations), income tax (personal income tax), central goods and services tax, union excise duty and customs duty.

Let’s take a look at the following table, which lists the total amount of tax that the government hopes to earn during this financial year against what it earned last year.

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The government expects to earn ₹23.2 lakh crore from its five big taxes this year. This is 20 per cent more than what it had earned last year. This increase in collections is unlikely.

The government expects the economy—as measured by the gross domestic product—to grow by 12 per cent (in nominal terms, without adjusting for inflation), during this financial year. In fact, this assumption is also extremely optimistic. The last time India grew by 12 per cent or greater was in 2013-2014. Since then, the growth has been lower than 12 per cent (as can be seen in the following figure). In 2018-2019, the economy grew by 11.2 per cent. 

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Source: Reserve Bank of India. 

It is worth reminding the readers here that the country is currently going through an economic slowdown, a slew of real-time economic indicators—everything from car sales to two-wheeler sales to non-oil, non-gold, non-silver imports—clearly suggest that.

Expecting the taxes to grow at 20 per cent when the economy is likely to grow at less than 12 per cent is being doubly optimistic. Also, since 2011-2012, the growth in the five main taxes (considering service tax before GST came in), has never been 20 per cent year on year. In this environment, how the government is going to earn 20 per cent more in taxes this year, is a question well worth asking.

The Indian economy and the government are like Basanti and Veeru, under the chains of an economic slowdown. Will Jai come to be their saviour? Let’s try and understand that.

Buried somewhere in the many documents of the Budget is the money that the government hopes to earn from the Dividend/Surplus of the Reserve Bank of India (RBI), Nationalised Banks & Financial Institutions. (Believe me, it was more difficult to find this number than for Jai to figure out how to get to Gabbar Singh’s den).

The government hopes to earn ₹1,06,042 crore through this. The public sector banks are hardly in a position to pay dividends to the government. In this scenario, a bulk of this will come from the RBI.

Finance secretary Subhash Chandra Garg said yesterday that the government expects 90,000 crore as dividend from the RBI, during the current financial year. The RBI makes a profit from its operations primarily because it almost pays no interest on its liabilities—primarily the paper money that it prints. At the same time, it earns interest on the assets that it owns—be it foreign government bonds or domestic bonds—which pay interest. Some portion of these profits is set aside as equity or capital, to maintain the creditworthiness of the RBI. The remaining is handed over to the government as a dividend. This typically happens in early August given that the RBI’s operational year runs from July to June.

Last year, the RBI had given a dividend of ₹40,000 crore, which was followed by ₹28,000 crore of an interim dividend. The government now has its eyes on what it calls “excess capital” of the RBI. The former Chief Economic Adviser Arvind Subramanian in his book Of Counsel—The Challenges of the Modi Jaitley Economy, writes: “Our estimate is that the RBI is holding excess capital between ₹4.5 lakh-7 lakh crore.” A committee led by former RBI Governor Bimal Jalan was set-up to look into this. The committee is yet to submit its report. Media reports suggest that most of the committee members are in favour of transferring the “excess reserves” of the RBI to the government in a phased manner, over a period of time. On the other hand, it seems that the government wants a one-time transfer. Which is why, the committee’s report is expected to contain a dissent note by the finance secretary, Subhash Garg, the government’s representative on the committee.

As mentioned earlier, the government’s assumption of 20 per cent growth in the five main taxes is extremely optimistic and is unlikely to be met. In this scenario, a huge dividend from the RBI will come as a huge help. Of course, if the tax growth doesn’t happen as expected, the dividend from the RBI will have to be in excess of the ₹90,000 crore, suggested by Garg.

Any attempt to get the RBI to transfer its so-called “excess capital” will impact the good international standing that India’s central bank has. Former RBI Governor Raghuram Rajan had suggested so in a speech, on his last working day, on September 3, 2016.

The good international standing of the RBI has acted in India’s favour every time there has been a foreign financial crisis, which could have negatively impacted India. Hence, the RBI may temporarily come to the government’s rescue with a much higher dividend than it should give, nevertheless, that will come with its own cost.

Also, the RBI may give an excess dividend for one year (or even two years) but what happens after that? Where will the government get that money in the years to come, given that government expenditure rarely comes down?

The government wants the RBI to play Jai and rescue it. But going back to Sholay, it is worth remembering that Jai dies in the process of rescuing Veeru and Basanti. Similarly, a higher RBI dividend will come up with its own share of costs. There is no free lunch in economics.

Vivek Kaul is an economist and the author of the Easy Money trilogy.

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