Deficit monetisation can keep interest rates down: SBI report

(Representative image)

MUMBAI: A report by State Bank of India has argued for keeping interest rates low with the government meeting its cash requirement by raising funds directly from RBI. RBI support would help the government fund the surge in spending due to the Covid-19 pandemic.
India’s debt to gross domestic product (GDP) which increased from 67.4% of GDP in FY12 to 72.2% in FY20 and is likely to hit 87.6% of GDP in FY21. The surge in borrowing could postpone by seven years the target date for containing fiscal deficit under the fiscal responsibility and budget management law.
A report by State Bank of India’s economics department said that direct monetization of the deficit could bring down interest rates and delay inflationary pressures arising out of the additional spending. According to SBI, this route is preferable to RBI selling bonds through open market operations.
“There has been a decline in money multiplier in the Indian context, thus it is unlikely that a direct monetization, if used as a policy option, will have any inflationary consequences given the stagnant demand. In fact, we believe at this juncture, open market operations could boost liquidity further and this could act as an enabler on inflationary expectations as currently food inflation,” said Soumya Kanti Ghosh, chief economist, SBI in a report. The money multiplier refers to the increase in money as a result of bank accepting deposits and lending it.
“If interest rates are higher than expected, then the cost of rolling over a given debt increases. There have been studies which show that if the difference between interest rate and nominal growth rate is negative then there is no level of debt which is unsustainable, i.e. the Government can borrow easily,” the report said.
The monetisation of the deficit refers to the issue of bonds directly to the Reserve Bank of India as against the practice issuing bonds at rates at which banks are willing to subscribe.
With total net borrowing rising to Rs 18.9 lakh crore, there is unlikely to be enough demand from investors. “We believe banks would demand Rs 5.91 lakh crore, insurance companies around Rs 4.74 lakh crore, mutual funds Rs 0.26 lakh crore and FPI around Rs 45,000 crore and rest by others, totalling to Rs 14.3 lakh crore,” the report said.
In the current year so far, total borrowing stood at Rs 4.48 lakh crore, of which 27% of bonds are below 5-year, 27% between 05-10 Years, and 45% bonds are long-term (above 10 years). The average (yield to maturity) YTM indicates that the long-term paper interest cost is still higher than the short-term bonds.

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