Interestingly, there is a discussion on why the Reserve Bank of India (RBI) should start printing money to revive the economy. Under normal circumstances this would have been scorned at, as this is what led several Latin American nations to their crisis of the 80s. Its supporters, however, aver that such a response would be Keynesian in spirit and would be driven by the government spending the money. Other experts have even been bolder to suggest that RBI should lend money directly to industry. Understandably, tough conditions lead to unconventional thinking, and such ideas are a manifestation of the same.
On the other side, there is an official view that the economy is not in very bad shape and that second wave-induced regional lockdowns will not push the economy back, except temporarily in the first quarter of 2021-22. This is why there has not been much action from the Centre. This is supported by some members of India Inc whose quarterly presentations say they expect demand to be exciting in the third and fourth quarters. If the economy is not really that badly off, then there is probably no need to discuss RBI stepping in.
Assuming that the economy does need help, and RBI has to intervene, what is the position really? In 1997, a decision was made to stop the automatic financing of the budget by RBI through the system of issuance of 4.6% T-bills by the government. In its place, ways and means advances (WMA) came in, which provided funds to meet temporary mismatches in revenue. The government had to borrow from the market for all its funding requirements. Further, once the government approached 75% of its WMA limit, market issuances were mandatory. As a matter of prudence, direct lending by RBI was not allowed.
However, there existed a route to indirectly facilitate the same through what are called open market operations, or OMOs, which are legitimate tools of monetary policy. If RBI felt at any time that the economy’s liquidity situation was tight, it could buy government securities (G-secs) from banks to ensure that they had funds for lending. Therefore, even though the primary issuance of these securities was subscribed by banks, OMOs could ease the situation when liquidity was under pressure.
Interestingly, RBI has been very active with OMOs in the past couple of years even while liquidity conditions varied significantly. In 2018-19, for instance, its net OMO purchases were ₹2.99 trillion, about 38% of its gross borrowings of ₹7.8 trillion. In 2019-20, it was modest at 15%, while in 2020-21, its net OMOs of ₹3.14 trillion were 24.5% of its gross borrowings of ₹12.8 trillion. Therefore, clearly, RBI has been indirectly financing the budget. which means that the level of government borrowing does not matter as the system will be stabilized by OMOs.
For the private sector, RBI already had various schemes like its long-term repo operations (LTRO), targeted LTRO, its more novel covid bank loan book and special LTRO. Neither the government nor the private sector can feel left out in the quest for funding, as RBI has been an agile partner in the growth process.
This means that the ball is really in the government’s court and the Centre has to think it fit to expand its fiscal deficit and raise funds in the market. This is where ideology matters. Even last year, the interesting thing about the budget was that the expanded fiscal deficit was more on account of a decline in revenues, including disinvestment, and an increase in relief rather than capital expenditure. Therefore, while the fiscal deficit moved from a budgeted ₹7.96 trillion to ₹18.21 trillion (accounts), capital spending increased by just ₹13,000 crore. RBI had ensured that liquidity was in abundance and that yields on G-Secs remained stable in the downward direction. One can argue that the government could have raised its capital expenditure without being bothered about the funding part. The banking system had surplus daily liquidity averaging ₹4.12 trillion that went into RBI’s overnight reverse repo window, with earnings of just 3.35%; G-Secs with an average yield of even 6% would have given a better return.
The takeaway is that today funding is not an issue, as the central bank has shown how it can manage liquidity and interest rates in a non-obtrusive manner. The economic push has to come from the government. Here, the recent Fiscal Responsibility and Budget Management guidelines have provided a good cushion to the Centre and states with respect to their deficits, and the new target of 4.5% by 2025-26 for the Centre offers a spending opportunity.
An interesting question is that even if the government is willing to increase its capital expenditure significantly, by, say, ₹1 trillion, are there projects which have been identified on which this money can be spent? When we talk of capex of the Centre of ₹5.54 trillion for 2021-22, ₹1.4 trillion is on defence, and the rest is on railways, roads and urban development, etc, which also includes around ₹30,000 crore as transfers to other institutions that would be on-lending the same. All said, we may have to moderate our expectations on how capital expenditure can be scaled up in the absence of clarity on the absorptive capacity that exists in terms of projects which can be taken on.
Madan Sabnavis is chief economist, Care Ratings, and author of ‘Hits & Misses: The Indian Banking Story’. These are the author’s personal views.
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