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Wednesday, September 23, 2020

Explained: How the government can arrest India’s GDP slide by funding its deficit

The SBI’s economics research team report has suggested the government raise funds directly from the RBI, through issuance of “Covid perpetual bonds” or such instruments.

Written by Sunny Verma , Edited by Explained Desk | New Delhi | Updated: July 21, 2020 7:23:05 am
India GDP, India economy, govt fund deficit, rbi, lockdown covid impact, express explained, indian express Monetisation of deficit would mean the Centre will be able to raise funds at a lower cost without putting pressure on the bond markets. (Express illustration)

A report by the State Bank of India has recommended direct monetisation as a possible way of funding the Centre’s deficit at lower rates, without increasing inflation and affecting debt sustainability. This is seen as crucial at a time when the country’s debt levels are rising, amid a likely contraction in GDP and falling government revenues.

The  SBI’s economics research team’s report notes that bringing growth back is the only mantra to a sustainable debt trajectory, and in this light, it has suggested the government raise funds directly from the Reserve Bank of India through issuance of “Covid perpetual bonds” or such instruments.

What is direct monetisation?

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 amounts of currency to meet its budget deficit. This practice was stopped over its inflationary impact and in favour of fiscal prudence.

The SBI report argues that the Fiscal Responsibility and Budget Management (FRBM) Act allows direct monetisation of deficit in certain exceptional circumstances, the Covid pandemic being one such. It expects this not to be inflationary, given the stagnant demand.

The finance ministry has so far not stated any view on monetisation of the deficit, though it has said it is open to all options.

What is pushing India’s debt levels?

SBI noted that 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 us back on track.

Most agencies expect India’s GDP to contract by more than 5 per cent this year, with April-June being the hardest hit. Shrinking revenues as a result of slump in economic activity means government will run far short of its revenue targets, forcing it to raise debt from the markets.

India’s debt-to-GDP ratio is projected to rise to around Rs 170 lakh crore or 87.6% of GDP in FY21, from Rs 146.9 lakh crore (72.2% of GDP) in FY20.

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Monetisation of deficit would mean the Centre will be able to raise funds at a lower cost without putting pressure on the bond markets.

Low interest rates and high GDP are crucial for debt sustainability, as higher growth means government’s revenue expansion will outstrip any spike in debt repayment.

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