The government's announcement that it will borrow an additional Rs 50,000 crore through dated securities should be looked at from the fiscal deficit and liquidity points of views where contrasting pictures emerge. It comes at a time when banks are net borrowers from the RBI through the repo window and hence does raise questions on the future of interest rates with the 10-years government securities (G-Secs) being above 7.25 percent. Also, the latest government accounts numbers show around 96 percent of the deficit has been exhausted by October 2017.
Why has this suddenly come about? The government’s revenue collections have been under pressure through the year on several counts. First, the expectations were that direct tax collections would be more than buoyant due to more tax assesses coming under the net post demonetisation. It does appear that so far, the expected tax collections from this section have not yet materialised.
Second, the non-tax revenue of the government has been lower this year mainly due to a shortfall of at least Rs 30,000 crore in the form of lower transfer of surpluses of the RBI. Here again it may be argued that the lower number compared with 2016 was mainly due to demonetisation episode.
Third, the GST that was introduced with clockwork precision has run into the channel of fine tuning where rates and processes are being reworked on a regular basis. The consequence is that the collections have fallen short and it is still not clear whether this equation will change and that there will be more tax payers this year.
The important thing to note is that the states have to be compensated for shortfalls in collections where state tax income was assumed to rise by 14 percent. Therefore the onus falls on the Centre to make sure that there are no shortfalls or else the states’ deficits would come under pressure and they would be unable to meet the 3 percent fiscal deficit target – where there is no flexibility provided under FRBM.
As a rule, this was flouted last year when deficits were allowed to overshoot the mark if they went in for the UDAY scheme, a discom restructuring exercise. The alternative is to have the central government breach the deficit target and borrow more from the market, which is being done now. An option of cutting expenditure was always on the table, but the fact that the government has decided to increase its borrowings suggests that there will be no compromise on capex where the programme will go as per schedule. This is a good sign for growth as the government is the only entity which is in a position to invest at a low cost.
Now higher borrowing of Rs 50,000 crore means that there will necessarily be a fiscal slippage. The fiscal target for the year is Rs 5.46 lakh crore and hence an additional Rs 50,000 crore being borrowed means approximately a slippage of 9 percent which will be tantamount to a ratio of 3.5 percent assuming nothing else changes (in case disinvestment exceeds the target or PSUs pay higher dividend there will be corrections as this borrowing will not be required).
Therefore, the conclusion drawn here is that there is a conscious call taken to have a higher fiscal deficit number this year due to the uncertainty in flow of revenue. Also it is implicit that the infra spending programmes will not be affected.
The second issue of liquidity is interesting. The government has reiterated in the press release that there will no change in net liquidity because it will be repaying T-Bills of around Rs 61,000 crore. This means that there has been excess borrowings through T-Bills which will now be redeemed so that money flows to the banks/institutions that have invested in them.
But theoretically in case these bills were held on till 31 March, the sum would have gotten added to the fiscal deficit number because the budget had spoken of only around Rs 2000 crore as being part of the fiscal deficit number.
Therefore, by running down the stock of T-Bills which are replaced by dated securities, liquidity has been created so that markets are not affected. But the fiscal deficit in both the cases would have been higher unless the redemption of T-Bills was not replaced with the dated securities issuances.
However, suppose we pose the question of ‘what if’ the borrowings were not enhanced and these T-Bills drawn down? In that case there would be more liquidity with banks to lend and the current situation of shortage of liquidity would have been alleviated.
Therefore, it can be counter-argued that the overall liquidity situation may not really be without costs even though the additional Rs 50,000 crore will not directly ask banks to invest from their new liabilities (deposits).
The comfort that can be drawn from the T-Bills being run down and making space for G-Secs issuances is that market disturbances would be limited in terms of yields on securities. While some change may be expected where the redemption is of shorter term paper while the issuance is of longer tenures, markets can treat this noise factor as causing minimum distortion.
The issue of liquidity is important because banks also have the challenge of being in a position to subscribe to the recapitalisation bonds to be issued by the government which will be invested back as either equity or Tier 1/2 bonds.
With banks already being net borrowers from the RBI it was going to be a challenge for them to subscribe to the recap bonds. Now with these new issuances of bonds by the government, there would be competition between the two.
If the markets are not affected perversely such a move should be welcomed as it is pragmatic. GST was a big reform required and the consequences were not known. But having it in place gives the comfort of achieving a lot and even though fine tuning will carry on for some more time, the machine has been set in motion which is important.
The higher fiscal deficit number this year will also provide a cushion next year, where the government need not aim for 3 percent but maybe 3.2 percent again, which will help it to expedite projects in both infrastructure and social expenditure which will be beneficial in the long run. Adhering to targets is prudent, but should not lead to over-caution because at the end of the day government should help in growth rather than ensure that statistically we are on the right path.
The writer is Chief Economist, CARE Ratings. He has authored ‘Economics of India: How to fool all people for all times’. Views expressed in this article are his personal opinion.
Updated Date: Dec 28, 2017 18:06 PM