Beyond borrowings
Govt must present a credible macroeconomic picture
It was only a matter of time for the Union government to revise the borrowing plan for the current fiscal year. The fact that it stuck to the budgeted borrowing target at the beginning of this fiscal year had surprised many analysts. The spread of Covid-19 and the ongoing lockdown have severely affected economic activity, as indicated by the latest Purchasing Managers’ Index. Contraction in economic activity will directly affect government finances. The government not only needs to spend on containing the spread of the pandemic but has to also support the economy with significantly reduced revenue. Thus, it has increased the borrowing target by over 50 per cent to ~12 trillion in the current year. But this may not be for a fiscal stimulus that many have been waiting for. Additional borrowing might largely be used to cover the shortfall in receipts. Apart from tax collection, the government would also witness shortfalls on account of lower dividend from public sector undertakings and disinvestment receipts, which are estimated at ~2.1 trillion in the current year.
Although expansion in government borrowing was inevitable, the manner in which it was announced left much to be desired, and might create confusion in financial markets. For instance, what are the assumptions behind expanding government borrowing by 53.85 per cent, and would this be enough for the year? The fact that government finances were under pressure even before the pandemic forced a virtual economic shutdown is making things more difficult. Revenue projections for the year were fairly optimistic and would now leave a bigger hole to be filled by borrowing. It is important for the markets to know if extra borrowing would largely be used to cover the shortfall in receipts and how the government intends to support the economy at this critical stage.
Further, the over 50 per cent increase in government borrowing will affect bond yields. While it is likely that the Reserve Bank of India will try to manage the yield curve through open market operations, it remains to be seen as to what extent it succeeds with the existing excess liquidity in the system. At some point the central bank would need to explain that if inflation is likely to remain under control and there is no risk to financial stability, why is the monetary policy committee not cutting policy rates sharply, which would have helped the government borrow at lower rates? Further, while the Central government has expanded its own borrowing programme, it is not clear how state governments, which are at the forefront of fighting the pandemic, are expected to manage their finances.
The government and its debt manager would do well to answer some of these questions urgently. To be sure, these are extraordinary times and Budget deficits are expanding all over the world. But it is important for policymakers to effectively communicate their stance in order to avoid uncertainty and chaos in financial markets. Whether it is internally accepted or not, weak growth and a deteriorating fiscal outlook can put India’s sovereign ratings at risk. Therefore, it is essential to go beyond just announcing a revised borrowing programme. The government should present a credible macroeconomic picture with a plan to return to normalcy. Transparency and effective communication at this stage can contain considerable damage.