Centre to borrow 54% more in FY21
The Central Government has decided to borrow an additional 54% (Rs12 Trillion) in FY21- from the market. This amount is revised- with a steep hike from the previous Rs7.8 Trillion estimated earlier.
The decision to increase its borrowings comes amidst the coronavirus pandemic, as the government is facing a shortfall in taxes and other revenues. The money will be used to revive a sagging economy (where currently, a lot of major sectors like automobiles are non-operational) and to take care of the health sector as it battles the pandemic. To address the COVID-19 slowdown the government had previously announced a hike in the fuel excise duty.
The plan so far is to borrow Rs6 Trillion in a period from 11th May to 30th September 2020, by issuing bonds and securities in the market. Bond Yields are the earnings that an investor realises on a bond they purchase. When an investor buys a bond they are essentially lending money to the issuer (here the Central Government). In return, the issuers agree to pay interest on this borrowed amount ( just like a loan) plus the face value of the bond upon its maturity. As of 11th May 2020, bonds yield have risen by 20 basis points (bps)-0.2%- in response to the steep hike in government borrowings.
As the yields of bond rise (interest rates) bond prices fall, and vice versa. Thus, due to an increase in the yields, bond prices have free fallen and banks who are left with a lot of idle cash (during this slowdown) have chipped in too. As a result, liquidity in the markets has increased. To keep the yields and market liquidity in check, open market operations (OMOs) are conducted by the RBI, by way of sale or purchase of Government securities. The RBI has not announced any OMO as of now, but it needs to intervene to maintain financial stability.
Another impact this announcement has is on the fiscal deficit. The FY20–21 fiscal deficit target of 3.5% (of the GDP) no longer holds as borrowings are means to finance a deficit. Experts have suggested widening of the deficit to 5.3% of the GDP. However, it rests on the assumption that the economy will grow by 10% at current prices. Given the current market conditions and the ever-worsening situation due to the pandemic, it is very difficult (one can even say impossible) for the market to grow by 10% in nominal terms.
No one knows when businesses will restart and revive- thus, the current scenario doesn’t give indications of growth predictions (or even contractions, for that matter) and hence the fiscal deficit can’t be predicted as of now. It will, however, widen and deviate from the current target.
State Governments too, are likely to borrow money using development bonds as states have to pay salaries, pensions, old debts and even spend on establishments. They need a way to fund these expenditures as their revenues are drying up. There is a limit set at State Government borrowings- 3% of the GDP. However, these rules should not be relevant for abnormal times like these- especially when borrowings are extremely necessary for fiscal expansion.
