The Reserve Bank of India (RBI), on Friday, announced a 60% increase in the Ways and Means Advances (WMA) limit of state governments over and above the level as on March 31, with a view to enabling them “to undertake COVID-19 containment and mitigation efforts” and “to better plan their market borrowings”.
What exactly is Ways and Means Advances (WMA)?
Simply put, it is a facility for both the Centre and states to borrow from the RBI. These borrowings are meant purely to help them to tide over temporary mismatches in cash flows of their receipts and expenditures. In that sense, they aren’t a source of finance per se. Section 17(5) of the RBI Act, 1934 authorises the central bank to lend to the Centre and state governments subject to their being repayable “not later than three months from the date of the making of the advance”.
How much does the RBI charge on these advances?
The interest rate on WMA is the RBI’s repo rate, which is basically the rate at which it lends short-term money to banks. That rate is currently 4.4%. The governments are, however, allowed to draw amounts in excess of their WMA limits. The interest on such overdraft is 2 percentage points above the repo rate, which now works out to 6.4%. Further, no state can run an overdraft with the RBI for more than a certain period.
What are the existing WMA limits and overdraft conditions?
For the Centre, the WMA limit during the first half of 2020-21 (April-September) has been fixed at Rs 120,000 crore. This is 60% higher than the Rs 75,000 crore limit for the same period of 2019-20. The limit for the second half of the last fiscal (October-March) was Rs 35,000 crore. For the states, the aggregate WMA limit was Rs 32,225 crore till March 31, 2020. On April 1, the RBI announced a 30% hike in this limit, which has now been enhanced to 60%, taking it to Rs 51,560 crore. The higher limit will be valid till September 30. The central bank, on April 7, also extended the period for which a state can be in overdraft from 14 to 21 consecutive working days, and from 36 to 50 working days during a quarter.
Why have all these relaxations been made?
The reason is simple. Government finances are in a mess today. The lockdown has resulted in revenues drying up, and it is the states that are actually feeling the heat. With economic activity at a near standstill, there is hardly any money coming in from GST, petroleum products, liquor, motor vehicles, stamp duty or registration fee. At the same time, the states are also incurring the bulk of the on-the-ground expenditures for combating the novel coronavirus. These extend not only to purchases of testing kits, personal protective equipment and ventilators or deployment of healthcare and police personnel, but even to providing food, shelter and other relief measures to those worst hit by the lockdown.
In a scenario where their expenses are real, mounting and cannot be deferred, even as revenues are collapsing and uncertain, the states are facing an unprecedented cash crunch. Most of them have resorted to slashing expenditures of other departments in order to meet COVID-19 exigencies, with some even deferring or cutting salaries of employees. But all these measures haven’t really addressed the underlying problem of liquidity and cash flow mismatches.
Can’t they borrow from the market?
The financial position of states was precarious even before the lockdown. The gross fiscal deficit of 22 states, as per latest available data, rose from 2.4% of their GSDP (gross state domestic product) in 2018-19 to 2.9% in 2019-20, with the corresponding revenue deficit ratio also climbing from 0.1% to 0.7%. Moreover, gross government market borrowings shot up from Rs 10,49,323 crore (Centre: Rs 571,000 crore, States: Rs 478,323 crore) in 2018-19 to Rs 13,44,521 crore (Centre: Rs 710,000 crore, States: Rs 634,521 crore) in 2019-20.
Given the current pressure on revenues as well as expenditures – not to speak of uncertainty over the COVID-19 outbreak’s “depth, spread and duration”, as the RBI governor Shaktikanta Das puts it – these numbers are likely to show further deterioration in 2020-21.
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The lack of clarity on how much the states (and even the Centre) would eventually need to borrow is reflected in bond yields. Since March 9, the weighted average yields (interest) at auctions of 10-year state government securities have risen from 6.86% to 7.57%. Yields on 10-year Government of India bonds, too, have gone up from 6.07% to nearly 6.5% over this period. This, despite the RBI cutting its repo rate from 5.15% to 4.4% (see chart).
So, will the increase in the WMA limits help?
The WMA window, as already pointed out, is intended only to tide over temporary mismatches in cash flow of receipts and payments. Given the likelihood of total government borrowings crossing Rs 20 lakh crore – a conservative underestimate – a WMA limit of Rs 120,000 crore for the Centre and Rs 51,560 crore for states may prove grossly insufficient.
At some point, the Centre, at least, might have to invoke Section 5(3) of its Fiscal Responsibility and Budget Management Act, 2003. That overriding provision in the Act – which otherwise bars the RBI from lending to the government, except for meeting temporary cash flow mismatches – allows the central bank to “subscribe to the primary issues of Central Government securities” under very specified grounds. Those cover, among other things, “act of war” and “national calamity”. Apart from monetisation of deficits – which is what this provision effectively entails – the RBI may, in the coming day, also have to undertake increased secondary market purchases and sales of Central as well as state government securities.