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Why RBI’s Bonanza Is a Palliative Amid the Evolving Fiscal Logjam

It is expected that the excess dividend transfer will enable significant bandwidth for the government to stimulate demand and spending on infrastructure, reducing fiscal deficit, and stimulating private capex. However, these are unrealistic expectations.
The RBI has announced a dividend payout of Rs 2.11 lakh crore for FY25 to the Government of India. Photo: Unsplash

The Reserve Bank of India’s latest announcement of a dividend payout of Rs 2.11 lakh crore for FY25 to the Government of India (GoI) is significantly higher than the interim budget estimate (BE) of Rs 1.02 lakh crore.

In fiscal year 2020, the central bank had last transferred such a massive quantum of dividend payout of Rs 1.76 lakh crore to the government.

In FY20 and FY25, the dividends were more than three times than the past five-year averages.

It is expected that the excess dividend transfer will enable significant bandwidth for the government to stimulate demand and spending on infrastructure, reducing fiscal deficit, and stimulating private capex.

However, these are unrealistic expectations.

As a percentage of the GDP, the oversized dividend payout in FY25 stands at 0.7% of the GDP. And of this, 0.3% was budgeted with an excess of just 0.4% of the GDP. Comparatively, it was 1.0% of the GDP in FY20, with an excess of 0.4%.

But why was there such a compulsion for such an extraordinarily high transfer of dividends from the RBI? Here’s an assessment of the dividend transfer on the fiscal situation and its impact on the economy.

Current macro situation akin to 2019

In 2019, the economy was “losing traction”, according to RBI governor Shaktikanta Das, for a variety of reasons. These were 1) weak household consumption, 2) low corporate profitability, 3) lull in private capex, 4) agrarian distress, 5) peak levels of unemployment, and 6) NBFC crisis was characterised by real estate lending and asset-liability mismatch. These were compounded by the intensifying US-China trade conflicts and government spending cuts in response to the tax collection shortfall.

The current situation exhibits 1) weaker consumption, employment, and income situation, 2) feeble sales growth of corporates, 3) elusive private capex cycle, 4) rising regulatory concerns on exuberant non-collateralised retail lending, and 5) renewed US-China trade conflicts with the latest imposition of punitive tariff on Chinese goods.

Also read: Numbers Don’t Lie: Public Debt Reduced in the Upa Era, Shot up Under the Modi Govt

Why is the RBI paying extraordinarily high dividends?

Relapse of tax revenue shortfall: While the budgeted growth in net tax collection in FY24 was less optimistic at 11.7% than in FY19BE (16.6%), the actual realisation at 6.8% (April-February, FY24) is significantly lower.

Though at 13.4% year-on-year (YoY) gross tax collection has been strong, higher devolution to states has implied a diminishing share of the government. Compared to the 41% devolution to the state, recommended by the 15th Finance Commission, the actual share transferred to the states averaged 31% during FY21-FY25BE. Given the backlog of deficient devolution from both the divisible (38%) and non-divisible pool (31%), it is likely that the artificial buoyancy in tax revenue to the GoI may dissipate going ahead.

If the net tax collection slows to 6% in FY24E, the projected tax revenue shortfall for the government could be Rs 1.2 lakh crore, or equivalent to the excess dividend paid by the RBI.

Exhibit 1: RBI’s surplus transfer to GoI surpasses the FY20 peak. Source: CMIE, Systematix Research

Core gross tax revenue is slowing: Despite peak levels of GST collections, the aggregate indirect tax of Rs 13.2 lakh crore (April-February FY24) has slowed to 5.1% (versus four-year CAGR of 11%).

The better-than-expected overall non-debt revenue growth in FY24 (11.6% April-February) is thus accounted for by higher income tax (25.8% YoY) and corporate tax (17.3%), resulting in 21.6% (Rs 15.6 lakh crore) growth in direct tax collections.

Importantly, income tax revenue (Rs 8.1 lakh crore) now exceeds corporate tax (Rs 7.6 lakh crore). The robustness of income tax collection could be due to skewed income distribution or the new income tax regime that excludes exemptions. Again, the profit growth of Indian corporates is skewed in favour of companies or sectors that have gained market shares and relied on margin expansion in the wake of slowing sales growth.

Thus, inclusive of indirect tax, which eventually gets passed on to consumers, and income tax, the total contribution of households in gross tax collections stands at 74%.

Looking ahead, higher devolution of tax revenue to states and slowing nominal GDP growth could impact net tax revenue for the GoI, thereby forcing higher reliance on non-tax revenue.

Higher devolutions to states led to a shortfall in revenue to GoI, compelling outsized dividends from RBI, like in FY19. Source: CMIE, Systematix Research, ^ Apr-Feb; BE = budget estimate, RE = revised estimate.

GoI has resorted to revenue spending cuts, reinforcing demand slackness

Akin to FY19, the under-shooting of net tax collections has prompted a sharp deceleration in the GoI’s expenditure to 7.3% in FY24 (April-February) from 11% in FY23. Additionally, similar to 2020, this is due to a significant cutback in revenue expenditure, excluding interest payments (-2% YoY), primarily in subsidies and economic services.

With household real consumption (or the private final consumption expenditure) growing at 3% in FY24 AE, despite the robust leveraged consumption and declining savings, the contraction in government revenue spending and higher tax incidence have reinforced the negative fiscal multiplier effect on households.

Also read: Does Household Consumption Data Confirm the Sustenance of Engel’s Law?

Can the RBI bonanza revive India’s core growth?

After the spending cuts in 4QFY19, the dividend bonanza from the RBI enabled the government to enhance revenue expenditure in the subsequent quarters with its growth reviving to 14% in the first three quarters of FY20. Despite this, the real headline GDP growth slowed further to 3.8% in the second half (H2) of 2019 from 6.3% a year ago. Private final consumption expenditure growth also decelerated to 6% (H2 of 2019) from 8%. Capital formation contracted by 1.3% YoY during the same period.

The current growth situation appears weaker than five years ago, with contracting revenue expenditure (1% in 1Q-3Q FY24), weak core GDP growth (GDP excluding discrepancies) at 3.2% compared to headline growth of 8.2% (1Q-3Q FY24), decelerating household income, and a higher incidence of inflation averaging 6% (FY22-24) versus 4% previously.

Thus, a similar proportion of the RBI’s excess dividend to GDP, at 0.4%, will likely be less effective in impacting growth given the more challenging current economic backdrop compared to 2019.

The RBI’s dividend bonanza is effectively rebalancing the shortfall in tax collections and preventing further intensification of the negative fiscal multiplier effect on the demand side, even as the GoI remains committed to reducing the fiscal deficit/GDP. Hence, on its own, this backfilling will not reduce the GoI’s fiscal deficit.

However, such a firefighting intervention will have a transient impact given the challenging backdrop of renewed US-China trade conflicts, regulatory intervention to curb uncollateralised retail lending, weak sales growth of non-finance companies, fiscal conservatism, a weak household situation, and the absence of 2019-type corporate tax cuts. Therefore, unless the GoI eases its fiscal strategy, the one-time bounty from the RBI will be inconsequential. Global trade conflicts can potentially revive uncertainty akin to 2019. Consequently, the recent easing of G-sec yields alone (10-year current at 7%) may not be a sufficient catalyst for private capex revival.

Dhananjay Sinha is co-head of Equities and head of Research of Strategy and Economics at Systematix Group.

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