Cut deficit, boom likely

Shivaji Sarkar *

A staggering windfall has hit the Indian treasury as the Reserve Bank of India delivers its largest-ever dividend of Rs 2.11 lakh crore. This colossal sum, a whopping 141 percentsurge from last year’s Rs 87,416 crore, has not only strengthened government finances but also set the stock market abuzz with wild speculation.

The RBI says the amount includes dividends from the public sector banks and other undertakings. The share market bounces BSE Sensex to an all-time high of 75,500 as the benchmark. Nifty similarly spurred to a high of 22,994. The perky share market, however, is no indication of a booming economy. Though it might shower bonanza on many players before the last two phases of the Lok Sabha elections.

Quite a few days back the bond market has been buzzing with certain movements. Soon after the dividend announcements government bonds slipped below 7 percent suggesting that the investors are at quick money in the stock market and government borrowings no longer remain lucrative.

The previous highest transfer was in 2018-19 of Rs 1.76 lakh crore. Some of the former RBI governors then were critical of the extravaganza as they suspected to have delved into the reserves that are used to keep the banking sector in good health.

This time too the 2024-25 budget had estimated a dividend of Rs 1.02 lakh crore. Nobody had speculated that it could be more than double of that. A pertinent question is what would the government do with this bonanza as the interim budget has taken care of most of the expenses the government is supposed to do during the year, including repayment of Rs 10 lakh crore plus debt.

The boom has enthused the share market as foreign portfolio investors withdrew a net amount of Rs 28,200 crore in equities in 2024 so far reportedly in a keenly-contested election. The FPIs withdrew Rs 17.000 crore in May alone. However, they invested Rs 45,000 crore in the debt market. So would they now transfer their debt investments into equities and have fluffy profits!

Some of the domestic firms that got a boost are no surprises as they were having profits. The record dividend is expected to help the government bring down its fiscal deficit to 5 percent of GDP from the budgeted 5.1 percent.

The government is on a spending spree of Rs 11 lakh crore on infrastructure. The likelihood of ramping up Centre’s revenue expenditure growth remains limited. Post-election, there would be less pressure to fund subsidies and revenue expenditures.

S&P Global Rating analyst says that India can get ‘rating support’ over time if it utilises the highest-ever dividend to reduce fiscal deficit. There are apprehensions that if the extra money that would reflect in the July budget is utilised to spend more it could add to inflation. Already inflationary pressure remains high despite a small slide in the consumer index recently.

The government might resort to more crash measures by the new government. The RBI has repeatedly said that it was under pressure to maintain the price line but the constant rise has prevented it from doing a lot many things. As the level of prices are very high it should have reined in with suitable rise in interest rates. That has not happened.

The RBI funding at this level is likely to create additional liquidity. At the time of demonetisation, in 2016, around Rs 15 lakh crore of currency notes were in circulation. Now, according to RBI, the currency in circulation has more than doubled to Rs 35.15 lakh crore by the end March 2024. It denotes that higher level of money circulation is at least one of the reasons for the rising of prices.

In addition, there is circulation of digital or UPI money. This also inflates the market though so far actual demand has not risen much and manufacturing has shown marginal increase.

India's industrial production growth slowed marginally to 4.9 per cent month-on-month in March 2024, mainly due to poor show by the mining sector, according to official data. The factory output growth, measured in terms of the Index of Industrial Production (IIP), was 5.6 per cent in February 2024.

It means the kind of actual money is not being generated suppressing the job market. In a situation like this, how does RBI generate such a surplus, that even on May 20, two days before the announcement of the windfall, suggested the dividend would not be that high.

The RBI attributes the windfall to a confluence of factors including a surge in foreign exchange reserves, loans to commercial banks and the government's proactive approach in managing contingencies. Potential sources of higher profits for the RBI include gross spot sale of foreign exchange reserves and higher interest income in the US market.

One of its methods was to buy dollars at Rs 78 and sell at Rs 83. With gross sales exceeding $150 billion in 2023-24, a significant portion of the dividend can be explained by these transactions, which were primarily carried out to generate the payout amount.

Somewhere the citizens paid the difference. It is noted that the RBI could have transferred an additional Rs 35,000 crore in dividends if it had not increased the contingency buffer around 6 percent. However, a former chairman of the 5th West Bengal State Finance Commission, Abhirup Sarkar, and a former professor at the Indian Statistical Institute, expresses reservations.

He says that the payment might not be from its income and the central bank could have used its reserves to pay the hefty dividend. He cautioned against the inflationary impact of injecting liquidity into the market, foreseeing a decline in real interest rates that could adversely affect retirees and individuals reliant on interest income.

The timing of the announcement amid the elections also has raised some questions. The bond markets would like the government to reduce its deficits. On the contrary, the equities prefer government increase expenses. Both have different purposes. But the country wants the banks, which have gone through phases of turmoil, to consolidate and add to the growth.