The RBI’s open market operations have created perverse incentives for the Government to do nothing about fiscal consolidation.
One would expect those who commit excesses to be penalised. But this rule does not seem to apply to the Government for its profligate ways. Four months ago, towards March-end, yields on its 10-year borrowings ruled at 8.63 per cent. Given its record of not taking any credible steps to check spiralling subsidies and other unproductive expenditures, these ought to have gone up in the current fiscal. Instead, in a recent auction, the Government has managed to raise a 10-year loan at just 8.11 per cent.
During April-July, the Government’s gross borrowings have been 37 per cent higher than for the same period of the previous fiscal. Yet, it has led to no increase in the weighted average yield of its issuances, at 8.5 per cent, even as their average maturity has risen from 12.7 to 13.6 years. That’s hardly any punishment for fiscal irresponsibility.
The main reason for the Government getting away with its extravagance is the weak demand for bank credit by corporates and other commercial borrowers. The absence of regular lending opportunities is reflected in banks’ holdings of government securities; these are now some Rs 450,000 crore in excess of their prescribed statutory liquidity requirements. This has been further aided by the Reserve Bank of India’s (RBI) open market operations (OMO) or outright purchase of securities. The OMOs have injected around Rs 210,000 crore of primary liquidity into the system, the benefit of which, however, has flowed mainly to the Government. The RBI may claim that lower yields on sovereign paper are only a by-product of its OMOs, whose basic objective is to ensure there is adequate liquidity in the financial system. But by enabling it to borrow cheaper, the OMOs are also giving rise to perverse incentives for the Government to do nothing about fiscal consolidation or even promoting growth that may rekindle demand for commercial credit. In the event, the ‘by-product’ completely undermines the ‘basic objective’.
There is a need, perhaps, for a re-look at the conduct of RBI’s OMOs. In today’s context, they have effectively become a means for the Government to get the central bank to print money to finance its deficits. True, the RBI no longer subscribes to primary auctions of government stock. But by buying these in the secondary market from banks, often just before an auction is scheduled, it is indirectly achieving the same results. The primary fault for this, of course, lies with the Government, which has not only given the go-by to principles of fiscal prudence, but has also, through its various policy inactions, created an environment where new investments have practically dried up. And unfortunately, unlike the rest of the economy, it is getting away by not paying a price for that.