Outgoing Reserve Bank Deputy Governor Viral Acharya has expressed the possibility that the rise in government borrowings in the second half of 2017 might have led to the asset-liability mismatch in the troubled non-banking financial companies (NBFC) sector and this “is worthy of further inquiry”.
“Might such forces have partly contributed to the surge in asset-liability mismatch of the NBFC sector for twelve months starting in the second half of 2017 when there was an upward revision in the quantum of government borrowings? I find this an intriguing possibility that is worthy of further inquiry,” Acharya said.
“Thus, not only does government borrowing crowd out the private sector, but it can also induce the private sector to borrow more short-term, which can increase financial fragility,” he said. A series of defaults by some NBFCs and housing finance companies since the second half of 2018 has severely hit the financial sector.
Acharya, who demitted the RBI post on July 23, six months ahead of the end of his three-year tenure, said the ability and willingness of NBFCs to borrow long-term comes down when government borrowing increases. “Not only does their total debt come down in response, but they rely more and more on short-term paper. When government debt increases by 10 per cent, the share of long-term debt for NBFCs comes down by 1.7 per cent,” he said while delivering the Federal Bank Hormis Memorial Foundation Lecture. The speech was released on the website of Federal Bank.
Remedy: Hike capex share, cut stake in PSUs
RBI Deputy Governor Viral Acharya has warned on the consequences of elevated government borrowings: lesser availability of resources for private sector, poor transmission of lower policy rates into market rates and pressure on non-banking financial companies to borrow short term funds, thereby increasing financial fragility. A remedy for this could be the government increasing its share of capital expenditure — which stands at a low rate of 14 per cent — and divesting stake in public sector enterprises to bring in efficiencies and reduce debt, he argued.
“If NBFCs rely on short-term debt and are hit by a shock, such as loan defaults or an inability to roll over the financing against illiquid assets, then they can experience the unfortunate confluence of asset-quality and funding pressures with adverse impact on their balance-sheets and future intermediation activity,” he said.
Acharya said high levels of issuance of public debt by the government can render monetary policy actions ineffective by interfering with the sound transmission of monetary policy, raise the cost of borrowings and crowd out the private sector from the market.
Acharya said, “as more government debt floods markets, the relative safety and liquidity premium attached by investors to high-rated corporate bonds diminishes, raising the cost of borrowing especially for AAA-rated borrowers and making it relatively less sensitive to policy rate cuts.”
According to him, when the central bank cuts the policy rate with a view to reduce economy-wide cost of funds, the ultimate objective is to make more and cheaper credit available to the economy, in part also by getting corporate bond market participants to accept lower yields. “Such pass-through of the RBI’s interest rate decisions (monetary policy transmission) is generally seen to be much weaker than one-for-one; a standard quarter-point (25 basis points) cut in the repo rate translates during the quarter into a 7.5 bps fall in yields for AAA-rated bonds and a mere 4.25 bps for BBB-rated ones,” he said.
On some possible remedies to alleviate the crowding-out effects of government financing, he said, “one possible solution is for the government to improve the share of capital expenditures which currently stands at a meagre 14 per cent for India. Serious rationalisation could be undertaken in the form of cutting back on subsidies and programs that are not delivering long-run growth, and instead, focusing on the provision of public goods … “ On June 24, Acharya, a strong votary of central bank’s independence who differed with Governor Shaktikanta Das on inflation, growth prospects and rates, resigned from his post “due to unavoidable personal circumstances”.
Monetary policy dept under Kanungo
Mumbai: BP Kanungo, Deputy Governor of the Reserve Bank of India, has been given the charge of Monetary policy Department of the RBI. Viral Acharya who was looking after this crucial department demitted the office on Tuesday, six months ahead of the end of his three-year tenure. Kanungo will also become a member of the Monetary Policy Committee which sets interest rates. —ENS
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