Raghuram Rajan says no free money: Govt fundraising using RBI, banks’ liquidity comes at a cost

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Published: July 23, 2020 7:11 PM

Raghuram Rajan revealed the reason why the banks are parking money with the RBI in the reverse repo window even at low earning.

Raghuram Rajan, RBI, COVID-19, coronavirus, indian economy, governmnet debtSince the banks have surplus liquidity at present, the government may ask the RBI to buy sovereign debt by borrowing from banks at the reverse repo rate.

Raghuram Rajan has said that the government’s plan to monetise debt using banks’ liquidity with the Reserve Bank of India’s help may not be sustainable. Since the banks have surplus liquidity at present, the government may ask the RBI to buy sovereign debt by borrowing from banks at the reverse repo rate. However, once the economy rebounds, such an arrangement may not work, Raghuram Rajan, former RBI Governor, said. There are limits to monetisation and the process can go long only for a limited period of time, he said.

After Indonesia’s central bank recently purchased $40 billion in sovereign bonds from the nation’s government to monetise debt, an Indian government official told The Indian Express that India too should not close this option. He added that the administration must discuss in detail what could be its impact on inflation, debt sustainability, and currency market, the report cited the official. However, if it happens, it will be the first time when the RBI will buy debt directly from the Ministry of Finance; so far the RBI buys debt through open market operations, Sameer Narang, Chief Economist, Bank of Baroda, told Financial Express Online.

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Meanwhile, Raghuram Rajan revealed the reason why the banks are parking money with the RBI in the reverse repo window even at low earning. At present, there is excess liquidity in the system as people get more risk-averse and save more and the demand for credit is sluggish, he said. At a conference organised by Singaporean lender DBS Bank, Raghuram Rajan also said that when people start fearing the extent of monetisation that is going on; start worrying about inflation and debt; or once growth starts picking up and banks find more borrowers; the process of financing government’s debt will have to stop.

He warned that once economies like India completely open up, the true picture of the damage to the private corporate sector will be unveiled. The resultant cost pressure will be transferred to the financial sector and the government has to ensure that lenders are adequately capitalised to tackle the situation and not call it a financial sector problem.

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