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Wednesday, August 05, 2020

‘Centre can fund deficit at lower rates through direct monetisation’

Under monetisation, the Centre can raise funds directly from the RBI via issuance of “COVID perpetual bonds” or such instruments.

Written by Sunny Verma | New Delhi | Updated: July 21, 2020 5:12:35 am
Most agencies expect India’s GDP to contact by more than 5 per cent this year, with April-June quarter being the hardest hit. (File)

Amid a spike in country’s debt levels and falling revenues, a State Bank of India (SBI) report has recommended direct monetisation as a plausible way of funding the Centre’s deficit at lower rates without increasing inflation and affecting debt sustainability. Under monetisation, the government can raise funds directly from the Reserve Bank of India through issuance of “Covid perpetual bonds” or such instruments. The report by SBI’s economics department noted that India’s debt to GDP ratio has risen substantially over the years, and contraction in growth this year could raise questions over debt sustainability.

The GDP collapse is pushing up the debt to GDP ratio by at least 4%, implying that “growth rather than continued fiscal conservatism is the only mantra” to get back on track, it said. Most agencies expect India’s GDP to contact by more than 5 per cent this year, with April-June quarter being the hardest hit.

“India’s debt to GDP ratio has increased gradually from Rs 58.8 lakh crore (67.4% of GDP) in FY12 to Rs 146.9 lakh crore (72.2% of GDP) in FY20. Higher level of borrowing this fiscal are likely to increase gross debt further to around Rs 170 lakh crore or 87.6% of GDP. Within this, external debt is estimated to increase to Rs 6.8 lakh crore (3.5% of GDP),” State Bank of India Group Chief Economic Adviser Soumya Kanti Ghosh wrote in the report.

The finance ministry has so far not taken any view on monetisation of the deficit, though it has said it is open to consider all options. The Fiscal Responsibility and Budget Management (FRBM) Act “clearly mentions that direct monetization of deficit can be used by the Government in certain exceptional circumstances. The current Corvid pandemic is one such, SBI said. And given the stagnant demand and low money multiplier, monetisation will not be inflationary, it argued.

Monetisation simply means that the RBI directly funds the Central government’s deficit. Until 1997, the government used to sell securities — ad hoc Treasury-Bills — directly to the RBI, and not to financial market participants. This allowed the government to technically print equivalent amount of currency to meet its budget deficit.

SBI report argued that bringing growth back is more important to debt sustainability as compared to fears of rating downgrades resulting just from higher deficit levels. While external debt is sustainable given the amount of foreign exchange reserves, domestic debt being internally financed is not a problem. The real challenge is the contraction of economic growth, which can turn interest rate minus growth differential — a key metric watched by agencies to gauge debt sustainability — into positive territory.

A negative differential, which denotes growth is higher than interest rate on debt, is important from sustainability perspective, therefore the emphasis on growth. The timeline to reach the target of 60 per cent debt to GDP ratio is likely to get extended by seven years, to FY30 only, as GDP has also been affected severely due to lockdown affecting economic activity, it said.

The SBI report comes amidst a series of meetings being taken by the Prime Minister’s Office possibly to prepare further measures to boost growth and economic activity. Industry has been suggesting that government provide a direct stimulus to demand through higher spending and lower taxes, while several economists have recommended a wider income support to lift people’s spending power.

With the easing of lockdown measures, economic activity showed an uptick but with fresh state-level curbs, many indicators are now plateauing. Data for electricity consumption, unemployment rate, mobility for retail and workplace have shown a flattening trend since mid-June with the initial spurt in consumption being seen as a sign of the pent-up demand.

Factory output has contracted for three consecutive months of March, April, May, even though the rate of contraction showed some improvement in May over the previous month. Even though the government has not released the headline number, the index values for Index of Industrial Production (IIP) reflect a 34.7 per cent contraction in May and 57.6 per cent contraction in April. Shrinking revenues means government has to look for funds to meet its own requirements as well as for providing any further stimulus. A monetisation of the deficit could help in resolving this challenge.

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