RBI Surplus Transfer: What Are The Realistic Outcomes?

The dividend payout for FY24 was significantly higher than the government's estimate of Rs 1 lakh crore. In FY23, the central bank transferred Rs 87,420 crore to the government.

"It would take months for the government to spend this money, especially in the current environment when you expect spending to remain subdued until the first half of July," Vivek Kumar, economist at QuantEco Research said.

This bumper transfer offers a choice to the government between faster pace of fiscal consolidation, higher spending, and lowering taxes, Kumar said.

While dividend transfer helps the government to meet its budgeted fiscal deficit target at 5.1% in FY25, most economists expect it to fall below 5% this year.

"The government can continue with its capex thrust by increasing allocations to roads, railways and defense. There is also room for the government to lower personal income taxes to boost consumption at the lower end of the tax pyramid," Kotak Securities said.

The financial system is currently in a liquidity deficit of over Rs 1 lakh crore. But, things are most likely to remain comfortable going forward.

The improvement in liquidity will be helped further by lower cash in circulation in coming months and consistent debt flows from foreign portfolio investor. 

"We see net liquidity surplus averaging around 0.5-0.8% of net demand time liabilities in coming three months vs current deficit of around 0.5% of NDTL," Madhavi Arora, lead economist at Emkay Global Financial Services said in a note.

In the interim budget presented in February, the government announced a borrowing plan of Rs 14.13 lakh crore at a record high in the financial year ending March 2025. Economists and bond traders remained divided on whether the government would cut its borrowing plan for the year now.

The government announced the capital expenditure outlay for FY25 at Rs 11.11 lakh crore, at 3.4% of the GDP. The capital expenditure for FY20, after the last Lok Sabha election and RBI's last bumper surplus transfer, stood at mere 1.7% of GDP.

The surplus transfer by RBI back then was Rs 1.76 lakh crore, but the durable liquidity did not get much of a boost.

Further, banks are not very euphoric on the large surplus transfer to the government as improvement in liquidity in the financial system, if any, may not necessarily make its way to the bank deposits until the second half of FY25, according to a senior official at a large public sector bank.

Another senior banking official at a large private bank expects that cost of funds may inch lower if the surplus funds are deployed towards capex.  

Banks, depending on which government securities are lying in their available-for-sale portfolio, will benefit accordingly as the impact on government bonds would not increase the valuation of securities held to maturity, the first official said.

Considering banks can transfer their bond holdings from held-to-maturity portfolio to available-for-sale bucket only up to 5%, there may not be any material rise in the banks' trading gains, the person added.

In reaction to RBI's announcement of surplus transfer, the yield on 10-year benchmark government bond ended at 6.99%, falling below 7% for the first time since June 2023. As yields drop, bonds become pricier.

Bond market traders have begun building expectations that the US Federal Reserve will cut interest rates once before November this year, along with other major central banks. This may result in a decline in the US dollar against global currencies, thereby easing pressure on the Indian rupee.

Now, along with the inclusion in JP Morgan bond indices, there is a possibility of natural flows also trickling down in the Indian assets, according to Mayank Prakash, deputy head of fixed income at Baroda BNP Paribas.

Likely intervention in the foreign currency market to limit sharp rise in the Indian rupee may provide comfort to liquidity in the banking system, he said. "We are entering into an overall macroeconomic space where we see easier financial conditions as well as start of the rate cutting cycle. Now the question will be whether the government would want to cut budgeted borrowing of FY25, or wait out," Prakash said.

He reads the large surplus transfer to the government as turning focus towards investments in terms of capex in infrastructure and manufacturing instead of consumption.

He expects the 10-year benchmark bond yield to drop to 6.9% by June.