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Do a big retail bond issue to part-fund COVID-plan

Banks don’t want to lend, so if `2-3 lakh crore of deposits flow to a 5% govt bond, a Covid-plan can be part-financed.

Market participants say that anticipation of announcements from the Reserve Bank of India (RBI) in regard to the absorption of additional government borrowing is keeping the bond market optimistic.
Market participants say that anticipation of announcements from the Reserve Bank of India (RBI) in regard to the absorption of additional government borrowing is keeping the bond market optimistic.
Given how the banks are not utilising the incremental deposits to lend, the government could tap into household savings by issuing retail Covid-19 bonds.
Given how the banks are not utilising the incremental deposits to lend, the government could tap into household savings by issuing retail Covid-19 bonds.

Given how banks are parking increasing sums with the Reserve Bank of India’s reverse repo window for a paltry 3.5%—on May 5, the amount was a staggering Rs 8. 53 lakh crore—it is clear they have little intention of growing their loan portfolios beyond a point. This paper has always maintained they should not be coerced into lending; that is a commercial decision best left to banks. However, since deposits continue to grow at a decent clip of 8-9% year-on-year, with individuals evidently comfortable leaving their savings with banks, this pool of money could be tapped by the government.

After all, it has been increasingly dipping into the small-savings pool—from just 1.8% in FY13, NSSF funds financed 19.7% of fiscal deficit in FY19, and possibly 18.5% in FY20. Moreover, this would not crowd out private sector borrowings as would happen if the government was to tap the bond markets for additional funds.

Suggestions on where the government should look for resources to boost a moribund economy range from overseas to local markets, with several economists arguing for a monetisation of the deficit—borrowing directly from RBI via Covid-19 bonds. Others have said the borrowings could be made against some kind of collateral—shares of government enterprises. As Samiran Chakraborty, chief economist at Citi India, has said, these primary market borrowings could be segregated from the rest of the government’s borrowings in a kind of standalone budget, so to speak. This budget could be wound down in a limited time frame, with the demarcation ensuring transparency, and also discipline, since the borrowings need to repaid within a specified period.

Another option that could be considered is retail tax-free bonds. Given how the banks are not utilising the incremental deposits to lend, the government could tap into household savings by issuing retail Covid-19 bonds. Even at a coupon rate of 5% tax-free, for a life of 10 years, individuals would be comfortable buying them; grossing up the 5% for a 30% tax rate would mean a coupon of close to 7%, a handsome return from a sovereign-backed security.

To be sure, the government will lose out on some taxes since the interest earnings on bank deposits are taxed, but it can mop up a large sum—Rs 2 lakh crore or even more—in quick time. Not only does the cost of borrowings go down—the10-year benchmark is hovering around 6%—but also the government can build in a couple of call options after, say, the seventh and eighth years.

The point is the government needs to spend—and spend big—to lift the economy, and it is woefully short of funds. Already, the expenditure in FY20, at Rs 27 lakh crore, was 3% smaller than budgeted. Moreover, the allocation of Rs 4.1 lakh crore for capital expenditure in FY21 may sound like a good 18% jump over the FY20RE, but a significant portion of that is earmarked for investment in government telcos.

With the economy set to contract by about half a percentage point in FY21, tax collections will likely fall way short of the budgeted target of Rs 23.89 lakh crore, with both direct and indirect taxes coming in at lower-than-expected levels. However, the government must make sure it spends enough to support the flagging economy. It must put idle money to work.

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