Is The Government Of India Using Accounting Measures To Boost Finances
June 15, 20o24
By Romar Correa*
Recently, the Reserve Bank of India (RBI), the nation’s central bank, committed supernormal profits to the Government of India. The expectation is that the budget deficit will be correspondingly reduced. However, the deficit contains durable elements. Built-in or automatic stabilizers chart its course over the economic cycle. Windfall gains like RBI profits could have been used as a shot in the arm of commercial banking that is on the path of secular decline.
An element in the macroeconomic identity of an economy is the government’s budget account. It is usually in deficit with expenditures exceeding income. Expenditures includes outlays on schools, hospitals, rural roads, public works and other programs. Income results mainly from direct taxes. In a large economy, the income figure might also be large but progressive taxation means the smaller base of higher income earners pay proportionately more.
All the Government of India’s crowing about the funds received from the Goods and Services Tax (GST) notwithstanding, it is an indirect tax and indirect taxes are regressive. They are imposed on items of mass consumption, raising prices for the poor and middle classes.
Typically, nowhere in a government’s budget accounts will a central bank’s profits figure as an income item on the balance sheet. The reason is that such profits are fickle, based on market valuations of investments held by the bank. So, the chances of losses are equally likely. In the case of a loss, the role of the government goes into reverse. The government’s deficit widens to recapitalize the central bank.
It is not that government deficits do not move widely. The cost of wars and tackling pandemics, as during the recent COVID-19 outbreak, widen a government’s deficit. However, most items of government expenditure are elements of choice. In the case of a central bank, especially when its surplus is the fruit of foreign asset holdings, the profit is the payoff of choices made by other governments, usually the USA in the case of the RBI. Almost 68% of the RBI’s balance sheet consists of foreign assets with a significant part invested in US government bonds.
The peculiarity of the application of the term ‘income’ to RBI ‘earnings’ is noteworthy. In 2022 and 2023, the US Federal Reserve Bank raised interest rates by 4.5%. This led to a sharp drop n the price of US government bonds. Consequently, the RBI had to increase its mark-to-market provision for a potential loss to account for the drop in market value of its US bond holdings. Hence, in financial year 2023, the RBI made a provision of Rs 71,239 crores ($9 billion) to cover such potential losses.
So far in 2024, US bond prices have risen since yields have softened. Yields on the ten-year treasuries, for instance, are currently 4.2%, down from around 5% in October last year. The RBI has used the accounting gain, resulting from the higher prices, to reduce its provision for potential losses on U.S. bond holdings by Rs 22,000 crores ($2.6 billion). If the expected decrease in interest rates continues through 2025, “the RBI may be able to still declare a large dividend even if profits from foreign exchange sales dip” The Times of India reported.
The same accounting artifice holds true for ‘expenditures’. Cumulative expenses dropped from Rs 1.8 trillion to Rs 428.2 billion in the current financial year, due to lower provisions made for government expenses. The axe seems to have fallen on “the asset development fund for which no provision was made. This fund essentially has money for investment in subsidiaries to meet internal capital expenditure,” according to The Mint.
Typically, governments issue bonds to finance their deficits. Government bonds compete with other bond investments, both corporate and foreign, and their acceptance or rejection reflects market sentiment about the issuer. In recent years, governments have been issuing green bonds in order to finance projects that seek to reduce and tackle the consequences of climate change. “However, India does not yet have an established ecosystem of investors with a mandate for subscribing to green bonds, traders said”, according to The Economic Times.
In most countries, green bonds are issued at a premium, with investors accepting the lower yield, called the “greenium”, for the noble purpose of underwriting environmentally-friendly schemes. The Indian government rejected all bids at the first sovereign green bond auction of this financial year. Flush with RBI profits, the Government of India could pooh-pooh the greenium.
Recently, and without reasons, the government of India recalled a large chunk of its gold holding held in the Bank of England. In a tutorial on the subject, The Economic Times cites international political uncertainties leading to freezing of assets held abroad and, peculiarly and contra factually, “decline in confidence in dollar assets among central banks”.
The causes for recalling gold holdings could be flipped. Domestic political uncertainty and a potential loss of confidence in the Indian rupee could be cited as reasons.
*Romar Correa retired as the Reserve Bank of India Professor of Monetary Economics, Bombay University.
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