{"id":3342,"date":"2015-03-14T10:02:13","date_gmt":"2015-03-14T04:32:13","guid":{"rendered":"https:\/\/teekhapan.wordpress.com\/?p=3342"},"modified":"2015-03-14T10:02:13","modified_gmt":"2015-03-14T04:32:13","slug":"yv-reddy-is-right-the-govt-borrowing-on-its-own-wont-work","status":"publish","type":"post","link":"https:\/\/vivekkaul.com\/2015\/03\/14\/yv-reddy-is-right-the-govt-borrowing-on-its-own-wont-work\/","title":{"rendered":"YV Reddy is right: The govt borrowing on its own won’t work"},"content":{"rendered":"
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\nIn the\u00a0budget speech he made on February 28, 2015<\/a>, the finance minister Arun Jaitley had said: “I intend to begin this process this year by setting up a Public Debt Management Agency (PDMA) which will bring both India’s external borrowings and domestic debt under one roof.” <\/span><\/span><\/span>
\n<\/span><\/span><\/span>The government of India, like most governments spends more than it earns. The difference it makes up through borrowing. This borrowing is currently managed by the Reserve Bank of India (RBI). Jaitley now wants to take away this responsibility from the RBI and set up an independent public debt management agency.<\/span><\/span><\/span>
\n<\/span><\/span><\/span>On the face of it this sounds like a simple move-one institution was taking care of the government borrowings needs, now the government wants to takeover the responsibility. But it is not as simple as that.<\/span><\/span><\/span>
\n<\/span><\/span><\/span>Before I explain why, it is important to understand something known as the statutory liquidity ratio (SLR), which currently stands at 21.5%. What this means is that for every Rs 100 that banks raise as a deposit, Rs 21.5 needs to be invested in government bonds.<\/span><\/span><\/span>
\n<\/span><\/span><\/span>This number was at higher levels earlier and has constantly been brought down by the RBI over the years. This provision helps the government raise money at lower interest rates than it would otherwise be able to.<\/span><\/span><\/span>
\n<\/span><\/span>This is something that the\u00a0<\/span><\/span><\/span>Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework<\/span><\/span><\/a>\u00a0<\/span><\/span><\/span>(better known as the Urjit Patel committee) released in January 2014 pointed out: “<\/i><\/span><\/span><\/span>Large government market borrowing has been supported by regulatory prescriptions under which most financial institutions in India, including banks, are statutorily required to invest a certain portion of their specified liabilities in government securities and\/or maintain a statutory liquidity ratio (SLR).”<\/span><\/span><\/span>
\n<\/span><\/span>This statutory requirement essentially ensures that there is a constant demand for government bonds. This helps the government get away by offering a lower rate of interest on its bonds.<\/span><\/span><\/span>
\n<\/span><\/span>“<\/span><\/span><\/span>The SLR prescription provides a captive\u00a0<\/i><\/span><\/span><\/span>market for government securities and helps to artificially suppress the cost of borrowing for the Government, dampening the transmission of interest rate changes across the term structure,” the Expert Committee report points out. <\/span><\/span><\/span>
\n<\/span><\/span>Take a look at the following chart. Between 2007-2008 and 2013-2014, the government was able to borrow money at a much lower rate of interest than the prevailing inflation. The red line which represent the estimated average cost of public debt (i.e. Interest paid on government borrowings) has been below the green line which represents the consumer price inflation, since around 2007-2008.\u00a0<\/span><\/span><\/span><\/p>\n