The domestic market can’t absorb enhanced govt borrowing without pushing up the yield rate; the govt may consider borrowing from abroad in foreign currency
By Barendra Kumar Bhoi
Although securing life and livelihood together is a challenging job, wisdom lies in converting challenges into opportunities. The Modi government’s endeavours have been to fight the pandemic head-on and simultaneously support the economy from collapsing. It announced a comprehensive Atmanirbhar Bharat package of Rs 20 trillion in five tranches during May 13-17, including nearly Rs 2 trillion relief package given earlier. The Atmanirbhar package carries the blueprint of the government’s vision for a new India in the medium term.
The government has steadfastly avoided soft options so far, like monetisation of deficit/debt, transfer of RBI’s reserves/contingency funds to finance stimulus package, asking RBI to open a direct window to finance NBFCs/MFs, etc. Many experts wonder as to how the government would finance the Rs 20 trillion package proposed in phases. While the uses of funds have been explicitly communicated by the finance minister, the sources of funds need better understanding to clarify misgivings surrounding the large package without a commensurate rise in the gross fiscal deficit-to-GDP ratio.
The package, in public domain now, has three elements—relief, rehabilitation, and rebooting of the economy through structural reforms. The bulk of the relief is being met by cash outgo from this year’s budget, which is around 1.2% of GDP, while sources of funds for rehabilitation and rebooting are distributed between future revenues of the government, the liability of the public sector units, and RBI.
A major part of the rehabilitation package is credit-led. The government has given credit guarantee for Rs 3 trillion collateral-free loans to MSMEs, besides equity support of Rs 40,000 crore and subordinated debt of Rs 20,000 crore. This is a bold decision to keep MSMEs afloat and prevent large-scale lay-offs. Also, revision of MSME definition would enable a wider segment of India’s manufacturing sector to survive and help reboot the economy.
RBI has been generous in making durable liquidity available through several channels like cut in CRR, OMO purchases, long-term repo operations (LTRO), targeted LTRO (TLTRO), special refinance, SLR exemption, etc. There is scope to cut the repo rate further and make LTRO/TLTRO funds available at a cheaper rate. Given the growth scenario, it may be difficult to have investment-grade corporate papers to the tune of Rs 8 trillion in FY21. Hence, RBI may have to change the conditionality associated with LTRO/TLTRO funds. Medium-term liquidity should be made available on tap for deployment as loans and/or investment in certain proportions, such that MSMEs are not deprived.
The Rs 20 trillion package includes Rs 8 trillion liquidity injected by RBI. The excess liquidity, which currently returns to the RBI balance sheet as reverse repo deposits, is likely to be utilised by the beneficiaries as proposed by the finance minister as soon as lockdown conditions are removed. Since the RBI liquidity is essentially the sources of funds, the Atmanirbhar package works out to Rs 12 trillion on a net basis.
Partial/full credit guarantee forms the contingent liability of the government, which has exceeded the permissible limit under the FRBM Act. In the wake of the Covid-19 pandemic, as fiscal arithmetic are unlikely to conform to the RFBM Act, there is a need to review the Act and draw a new timeline to achieve medium-term objectives of fiscal consolidation in India.
Part of the relief programme is being met by the Food Corporation of India (FCI) in the form of distribution of free cereals/pulses. FCI-led relief will devolve on the government and add to its liability in due course, although it is initially considered as extra-budgetary resources. There is no free lunch anyway. Food security being a government programme, the government has to foot the bill to FCI sooner or later.
Rebooting the economy can be done in two ways—through structural reforms and fiscal stimulus or a combination of both. Structural reform proposals in the Atmanirbhar package are many and far-reaching, covering agriculture, industry, mining, infrastructure, defence production, etc. The epicentre of Covid-19 disruption being the real sector, the government has to widen its structural reforms to several areas, besides continuing with ongoing reforms. In fact, the coverage of structural reforms this time is much wider than in the early 1990s. This may invigorate the economy in the medium-term if implemented in a time-bound manner.
The Union government’s fiscal deficit in FY21 is likely to increase from 3.5% to 7% of GDP, mainly due to shortfall in revenues and disinvestment. Moreover, the limit of state governments’ borrowings has been increased from 3% to 5% of their respective gross state domestic products, of which 0.5% is unconditional and the rest is conditional. The combined fiscal deficit may vary between 10.5% and 12% of GDP in FY21. As the fiscal space is limited, the government has not been able to give adequate fiscal stimulus so far. However, this may be necessary, going forward. Unless economic activity is fully restored, any fiscal stimulus to augment demand at this stage may go waste. Hopefully, the government may consider fiscal stimulus at a later stage, but limited fiscal space may constrain this effort in a big way.
As the domestic market is unable to absorb the enhanced government borrowing without pushing up the yield rate, the government may consider borrowing from abroad in foreign currency, either directly or through PSUs under government guarantee. Floating of Covid-19 tax-free bond for $15 billion in the overseas market, open for all non-residents, including NRIs, may be considered. If necessary, the government may resort to borrowing under bilateral swap arrangements for a similar amount, besides obtaining concessional loans from multilateral institutions like the IMF, the World Bank, the ADB, and the NDB. This would offset the outflow of capital due flight to safety, and smoothen liquidity management as RBI’s short-term liquidity windows expire.
The author is Visiting fellow, IGIDR, & former head of RBI’s Monetary Policy Department
Views are personal