- With the lockdown in place, banks are hardly giving out loans
- Even when the lockdown is lifted, businesses would take time to return to normalcy
During times of stress, the Reserve Bank of India (RBI) has stepped up its efforts to support the government raise funds from the market at reasonable rates. After all, the private sector could borrow cheap only if the government got its money at a low cost.
So, in view of the covid-19 outbreak, it is not unreasonable to expect the central bank to swallow government bonds through open market operations (OMOs). Analysts are expecting RBI to enhance its bond buying exponentially, perhaps even swallowing 70% of the borrowing ( ₹7.9 trillion) for the current year. Recall that in FY19, RBI had ended up absorbing that much through OMO purchases, although the compulsions back then were about liquidity.
“They will have to do large OMOs of course,” said Madan Sabnavis, chief economist a, CARE Ratings, adding that government finances would be under considerable strain.
But a more worrying prospect has emerged in market chatter—that of direct monetization in which RBI directly buys bonds from the government.
The central government’s tax revenues are expected to suffer, even as compulsions to give relief packages to revive the economy rise. Will OMOs be sufficient to absorb the higher fiscal deficit?
“Monetisation of the deficit is inevitable. Such a large increase in expenditure cannot be managed without monetisation of government debt,” said former RBI governor C. Rangarajan in an interview with BloombergQuint. Under the Fiscal Responsibility and Budget Management Act, RBI had stopped the practice of direct monetization in 1997. The rationale was that central governments could fall prey to “print and spend” without any scruples with a central bank monetizing the borrowings. This would flare up inflation in a supply-constrained economy like India.
A. Prasanna, head (research) at ICICI Securities Primary Dealership Ltd, said it would be the last option. “Fiscal deficit is getting monetised indirectly through OMOs. Direct monetisation may be needed but not at the moment.” Prasanna reasoned that the first-half borrowing can be managed through OMOs with banks being eager buyers in the absence of credit offtake.
With the lockdown in place, banks are hardly giving out loans. Even when the lockdown is lifted, businesses would take time to return to normalcy. Ergo, credit growth is unlikely to pick up, leaving banks with ample funds to park in government bonds.
So far, RBI is giving cash to the government through enhanced ways and means, and even via OMO bond purchases. It remains to be seen whether it will have to hand over its wallet by monetizing the deficit directly.
Meanwhile, bond yields have risen over concerns that logistical issues due to lockdown and uncertainty over the economy may hit borrowing. It would be a good time for RBI to announce OMOs to boost confidence.