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Impact on the Government
The Government of India does not raise resources from the international capital markets to finance the fiscal deficit, though the bilateral and multilateral sources do provide moderate amount of foreign currency funds. The Government could, therefore, be affected indirectly through the spill-over impact of external developments on domestic interest rates. What is of relevance, inter alia, is the nominal international interest rates and domestic interest rates, adjusted for inflation differential. To the extent there is a rise in domestic interest rates, there could be an increase in the cost of government borrowings of the Government. Since most of the outstanding debt is at fixed rates and not on floating rates, the rise in the borrowing cost will be incremental. This situation also provides greater headroom for a flexible monetary policy to adjust policy rates, as and when warranted, without any excessive impact on the fiscal deficit.

Impact on the Reserve Bank's Balance Sheet
The fiscal position of the Government could also be indirectly impacted through the nature of management of foreign exchange reserves held by the Reserve Bank. Volatility in the foreign exchange market exposes foreign exchange reserves to both operational and market risks. Depreciation in the value of any reserve currency vis-à-vis the domestic currency would result in an equivalent decline in the value of the reserves held, though the impact may be mitigated to some extent through appreciation of other currencies in which foreign exchange reserves are held. Also, increase in global interest rates would entail capital losses on the corresponding assets, including fixed income securities. Valuation and capital losses could impact the income of the Reserve Bank of India and thus, its surplus transferable to the Government which, in turn, would have fiscal implications. It is pertinent to mention that the Reserve Bank of India, as a matter of prudent practice, follows conservative accounting norms whereby the valuation gains/losses on foreign exchange reserves and gold are not taken to the profit and loss account, but instead, booked under a separate reserve head.

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