The latest Monetary Policy was along expected lines, on the surface. But barely below the surface are some concerns that pose a host of questions with implications far beyond the immediate. The inflation outlook has downside risks, and has been revised to the higher side at 5 per cent but growth outlook has been kept at 10.5 per cent. The onset of a second wave of the Covid-19 pandemic and a new spate of lockdowns are already disrupting the supply chain amid reports of reverse migration. As a result, the growth outlook may not be as bright as the RBI has assumed.

That apart, the RBI Governor’s statement conveys many attention-grabbing issues under the broad head of liquidity guidance, notably that it will support the market with adequate liquidity through various instruments in its toolkit. Three important observations in this regard pertain to (a) successful completion of the market borrowing programme in fiscal 2020-21 amounting to “₹22-lakh crore at record low costs with elongated maturity”, (b) scale up of the open market operations (OMO) to the tune of net outright purchases amounting to ₹3.13 lakh crore during 2020-21, and (c) G-SAP 1.0 comprising of secondary market purchase of government securities by the RBI.

In the words of the Governor: “We have decided to put in place what is termed as a secondary market G-Sec acquisition programme, or G-SAP 1.0, to give it a distinct character”. The G-SAP 1.0 operation has been claimed by the RBI management as “innovative” and “a balance sheet approach to conduct monetary policy”. The argument also offered is that the government asset purchase is a “high quality asset purchase” and will help in developing a “stable and orderly evolution of the yield curve amidst comfortable liquidity conditions”.

The total such purchase has been kept at ₹1-lakh crore, with the first purchase of government securities for ₹25,000 crore under G-SAP 1.0 scheduled for April 15. The very nomenclature, ‘G-SAP 1.0’, suggests that further versions will follow. This is not a one-time activity.

Mimicking Fed, ECB

The approach mimics the moves of central banks of advanced economies, notably the US Federal Reserve and the European Central Bank (ECB), in the aftermath of the Global Financial Crisis (GFC). They undertook the Asset Purchase Programme (APP) as an unconventional monetary policy to support aggregate demand revival to address contraction in these economies. Subsequently, as interest rates fell to near-zero, the monetary policy by engaging the interest rate channel failed to be effective. As a result, the APP continued.

In the Indian context, G-SAP announced by the RBI broadly follows the APP of advanced economies. It is important to note that in the advanced economies, OMO and APP are undertaken to ease money supply whereas in the Indian context OMO and G-SAP 1.0 are by the very design meant to help the government’s market borrowing programme in the name of developing the yield curve and keeping orderly market conditions. The yield curve should be developed by the market itself and not by liquidity support from the central bank.

Turning to balance sheet issues: OMO net purchases and G-SAP 1.0 impact the balance sheet of the RBI as assets increase and an equivalent amount of liabilities are created by printing money. Such an expansion of the balance sheet to finance the fiscal deficit of the government needs to be seen in the context of the Indian situation where a high fiscal deficit is the result of a high revenue deficit. For example, the revenue deficit in 2020-21 (Revised Estimates) relative to GDP at 7.5 per cent accounted for 78.9 per cent of the fiscal deficit. In the 2021-22 (Budget Estimates), the revenue deficit as a proportion of GDP at 5.1 per cent is estimated to pre-empt 75 per cent of the fiscal deficit. This tells us that costly borrowing has been used for current consumption.

This is also reflected in the fact that the Government has a significant excess in liabilities over assets to the tune of 35.9 per cent in 2020-21 and 36.3 per cent in 2021-22 because borrowings over the years were spent on current consumption, resulting in the revenue deficit.

Wither fiscal prudence?

The above development is a pointer to the fact that there is no regard to fiscal prudence initially set out in the FRBM Act, 2003, which was completely diluted in the amended Act of 2012 and 2018. No more do we regard revenue deficit elimination as a pillar of fiscal legislation. The great legislative achievement of the original FRBM has been reduced to naught.

We must ask what is the intention of this so-called balance sheet approach: Is it to develop the yield curve or is it in effect a creative accounting in balance sheet management that opens the routes to printing money to finance the fiscal deficit, the root cause of which is the high magnitude of the revenue deficit? So, the question that emerges is this: Should the central bank print money to meet the revenue deficit of the government? Should it expand its balance sheet in the name of monetary policy to finance the fiscal deficit?

In 2006. the FRBM Act was amended to prohibit the RBI from participating in the primary segment of the government securities market (GSM). Following this, the Ways and Means Advances (WMA) limits were increased with the intention of smoothening cash management but, in effect, it has been used to finance the fiscal deficit as year after year, the WMA limits have been increased. In the current fiscal H1, the total WMA limit has been fixed at ₹1,20,000 crore. Now, OMO net purchases and G-SAP 1.0 in effect have been designed to lower the cost of government borrowing by monetisation of the fiscal deficit.

The balance sheet approach to conducting monetary policy has a moral hazard problem in the sense that the RBI will print money, keep the securities in its portfolio and earn interest in the end. This interest income will be passed on to the government by surplus transfer. The RBI is the monetary authority, banker to the government, debt manager to the government and, more importantly, in these roles also the fiscal adviser. The debt management function should not overshadow the function of the monetary authority.

Little impact of rate tweaks

There is no escaping the simple fact that we have hit a road block in so far as policy repo rate reduction is concerned; the repeated moves at lowering the rate have not revived growth, as evidence suggests. Further, if inflation is caused by food, the RBI monetary policy is again helpless. Therefore, what the RBI is trying to do in the name of an innovative process is encouraging creative accounting through G-SAP, which is intended to conduct money policy through the balance sheet. But all prudent thinking will tell us that a balance sheet should be sacrosanct, almost be handled with a purist’s approach, untouched by short- term and narrow goals that can destroy credibility in the long run. What is being achieved in the end is the reduction in interest rates for the government. What is being lost in the process is not quite accounted for!

The writer is a former central banker and a faculty member at SPJIMR. Views are personal. (Through The Billion Press)

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