The challenge of high-risk deficit financing is the uphill battle ahead, says Ajit Ranade

India’s third quarter GDP data shows it has emerged from recession. The data shows a substantial increase in consumer spending of nearly 18 percent from the previous quarter. This shows positive consumer sentiment. GDP growth turned positive and there are signs of continued upward momentum in the fourth quarter as well.

As we look into next year, there is understandable optimism for a strong V-shaped recovery and nearly 11% growth. But much of next year’s strong growth is believed to be due to the economy simply picking up ground lost in the pandemic year. As a result, after two years India’s economic size would be barely 2-3 percent larger than it was in 2019. The presentation of the Union’s budget proposals in February has gone a long way in reviving the economy. consumer optimism and business confidence. .

Record farm production

The expected strong growth will depend to a large extent on the direction to be taken by the private sector, in strong consumer spending, as well as in industrial investment. The investment / GDP ratio must rise from the current 28% to almost 36% for the economy to post a sustained growth rate of 8%. Fortunately, agricultural production reached a record high of 303 million tonnes this year. This is almost 10 percent more than the average for the previous five years.

A resolution of the deadlock in negotiations between the central government and farmers who have opposed the new farm laws for more than four months will go a long way in reviving optimism for growth. It will also address the shortages that have arisen due to the blockade and disruptions in the delivery of essential inputs such as charcoal, fertilizer and even transport fuel to Punjab and neighboring states.

One of the main reasons for next year’s growth optimism stems from the fiscal expansionist stance adopted by the Minister of Finance. Even though overall spending is only expected to increase by 1 percent, infrastructure spending will increase by almost 25 percent. And health spending, including vaccinations and sanitation, has increased by nearly one hundred percent.

Two notable characteristics of the Union budget were, on the one hand, transparency in the disclosure of all commitments, and on the other hand, the admission of a very large budget deficit. This large 6.8 percent budget deficit for next year is not only well above what has been specified by India’s own fiscal responsibility law, but it is also stinging international rating agencies. There is an irreverent contempt for the fear of downgrading. A full chapter of the Economic Survey explains how international rating agencies have always been unfair to India despite the country’s history of zero defaults and currently, a high stock of foreign currency.

Financing the deficit

But this high-risk deficit, while bold and ambitious, should not make us complacent in the face of the challenge of financing it. The need for gross borrowing by the Center alone is over 12 trillion rupees, or 1,000 billion rupees per month. This is roughly equal to the monthly GST collection. The total borrowing requirement will swallow up all of the extra deposit in the banking system, assuming 8% growth next year.

If capacity expansion and private sector investment require an additional 12 trillion rupees, it will put pressure on interest rates as there is not enough financing available to meet this huge need for investment. borrowing. In fact, when you factor in the borrowing needs of state governments, as well as those of public sector companies, that number is over Rs 23 trillion. This huge loan simply cannot be covered by available household savings in the country.

This is where the Reserve Bank of India must step in. Of course, she can’t just print money, as that would amount to monetization, which is explicitly prohibited by a 1997 deal between the RBI and the Center. Also, direct monetization could be inflationary. The RBI can perform indirect monetization, by purchasing all Indian government issued bonds in the secondary market.

Indeed, he has been doing it for two years. When he buys the bonds for the money he created, the RBI’s balance sheet grows. This toll has increased by 50 percent over the past two years. And it will increase even more. But a huge volume of borrowing through the market process, i.e. the sale of bonds, can put upward pressure on interest rates and crowd out private investment, which seeks them. also to borrow from the same banking system and from the capital markets.

Bilateral love agreement

One way to alleviate this pressure is for the RBI to enter into a direct deal with the Center and provide a five-year fixed-term loan at a low interest rate relative to a pledged asset. This promised asset could be all the shares that the Indian government owns in public sector companies. The combined value of all the shares held by GoI today is over Rs 20 trillion, thanks to the exuberance of the stock market. Such a bilateral deal is technically not monetization, prohibited by the 1997 deal, nor disrupting credit markets and hopefully relieving pressure on interest rates as well.

Another source of funding for the Indian government is, of course, foreign funds. Fortunately, the entry into the rupee-denominated government debt market has been quite strong and is expected to remain so next year. The government may also consider floating a semi-sovereign bond denominated in international dollars through a proxy, such as the State Bank of India. This too can raise funds equivalent to Rs1 or $ 2 trillion.

Obviously, none of the financing required can depend on increasing the level of taxation as the economy emerges from recession. So, next year will be a difficult balancing task for the RBI. On the one hand, ensure adequate funding for the government and, on the other hand, not to let inflation or interest rates get out of hand, while maintaining the stability of the currency. Not at all an enviable job!

The writer is an economist and Senior Fellow, Takshashila Institution

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