Unfounded fiscal deficit fears : Mint 14th July 2009

Concerns that the government borrowing programme will crowd out private investment have been overstated

A view normally held is that higher government borrowing tends to put pressure on interest rates—which, in turn, affects the private sector’s ability to invest, and, hence, probably growth. The rationale is that there are fixed sums of money available with banks which have to be deployed as credit or investments. When the government borrows more, then there are fewer funds available for the private sector and there is a crowding out phenomenon. Further—even if funds are available—the cost goes up as yields on bonds rise, which sets the pitch for the deposit and credit rates as they indicate the risk-free rates that have to be adjusted with the premium to be charged. Intuitively, when more government paper floods the market, the price of government bonds decline due to oversupply conditions which, in turn, push up yields. Also See The fiscal deficit for the year is around Rs4 trillion and the borrowing level in net terms is around the same level. Government officials have maintained that there is not going to be any significant crowding out because there are surplus funds in the system to the tune of Rs1-1.5 trillion presently that are being invested by banks in the reverse repo auctions. Therefore, while interest rates are not expected to come down, they would also not move up significantly to cause disturbances. What, then, is the true picture? The accompanying table provides a peep into the past to show how these numbers have tallied when borrowings were high. The first column provides information on the difference between incremental deposits and credit every year, which is the unadjusted surplus (before accounting for the cash reserve ratio, or CRR) that banks could invest in government paper. The difference between these surpluses/deficits and the net government borrowing programme is seen in the next column as the “system’s deficit”. This gives the deficit that was created on account of the government’s borrowing programme after considering the surpluses that were available with banks from their incremental deposits. Different interest rates, such as the prime lending rate, deposits rate for one year, reverse repo and repo rates and the 10-year bond rate, have then been juxtaposed to discern the reaction of interest rates to this situation. It’s not wrong to say that interest rates have been influenced more by policy rates than by existing liquidity Now, the deficit in funds has been present in eight of the 10 years, with the deficit being very high in fiscal 2005 and fiscal 2006, which has now peaked in fiscal 2010. However, interest rates have shown a continuous decline up to fiscal 2004 and fiscal 2005 and then increased subsequently before declining in fiscal 2010. The rate of increase or decline in interest rates has not been related to the quantum of the system’s deficit increasing or decreasing, and appears to be more a part of a trend. In fact, it would not be incorrect to say that interest rates have been influenced more by policy rates than existing liquidity. Government securities (G-Sec) rates were relatively marginally more related with liquidity when the deficit was high. There is evidently a conundrum here, where we are witnessing large borrowings that are not being financed by the banks, leading to a deficit. Yet, there are surplus funds in the banking system as evidenced in the reverse repo auctions. And interest rates are not in sync with the liquidity trends. How does all this add up? To begin with, it must be pointed out that banks are one set of entities that purchase government paper. Reserve Bank of India (RBI) data for March shows that banks hold around 40% of government paper, followed by insurance companies with 23%, RBI with 10% and primary dealers and provident funds with around 10% each. Therefore, while banks are the most important supplier of funds, the same flows from other entities too. Two, the market stabilization scheme (MSS) of RBI helped to absorb surplus funds a couple of years ago, and these funds have been used astutely to finance the government borrowing programme in the form of unwinding of the same. Three, RBI has been reducing CRR at regular intervals to provide more funds. Since September, for example, a reduction of 400 basis points in CRR meant a supply of at least Rs1.5 trillion. Lastly, key bank interest rates have been guided, though not dictated, more by policy rates than implied liquidity. In fact, even the G-Sec rates which should be most affected by liquidity have a countervailing force that works in the government’s favour. When deposits growth is tardy, savings get channelled into other avenues such as insurance or provident funds which, in turn, invest in government paper. Hence, as long as the gross domestic product is growing and the marginal propensity to save is increasing, there will always be funds for the government—unless there is a major shift to the capital markets. Besides, bank deposits are rarely substituted with equity, as the class of investors is different, as is the risk profile. All this means that we really may not have to despair of the large government borrowing programme for the year, and the system may just be able to tide over this hurdle with minimum pain.

Why should anyone farm? 3rd July 2009 Financial Express

The Union Budget is normally seen as a policy package or concessions to be given to India Inc while paying formal obeisance to the common man by giving a few concessions. Agriculture and rural development keep getting allocations that have never really been analysed; and with the exception of the NREG, which has been successful, there has been no concerted action taken to boost agriculture. The Economic Survey, which is a precursor to the Budget, shows that even though agriculture plays a vital role in the prospects of industry besides sustaining employment to a large number of households, its share in GDP has declined from 21.7% in FY04 to 17.8% in FY09. Also, its share in capital formation has been declining over the years. As the recent monsoon forecast is not too favourable, we need to address this issue head-on in the Budget. The government’s reactions to droughts, low harvests and suicide deaths have followed a fixed pattern. To begin with, we delay the acceptance of the problem. When the problem arises, we brush it aside as being atypical and not pandemic. Then we panic and look for the causes. While trying to apportion the blame, we decide to import the product. When India decides to import, we push up global prices and end up paying more. The solution is in terms of increasing MSPs quite mindlessly —mindless because while this helps to reward the farmer better for one crop, it leads to crop shifting which solves the problem of one crop but transfers the same to another one. Also, once increased, prices cannot be rolled back. Budgets react to an agrarian crisis by going in for loan waivers and interest rate subventions that transfers the problem to banks. When they cry foul over their NPAs and lower profits, the amount then gets into the fiscal deficit of the government. Intuitively the question that should be posed is whether or not it is possible to eschew this chain of agony by simply budgeting for practical numbers in a phased manner based on a firm policy. In simple terms, this means that we need to have a comprehensive farm policy that tackles the issues of land under cultivation, inputs for farming and improving yields. The Economic Survey has highlighted that food grains production in FY09 was just about at the same level as FY08. Also, the area under cultivation has come down for food grains and oilseeds and increased marginally for sugarcane. Not much progress has been witnessed in area under irrigation except for oilseeds in the last decade, while productivity remains stagnant at best. With output levels remaining uncertain, farming is not an attractive proposition today and there has been a tendency for migration to the urban centres where unskilled labour still finds jobs that provide a sustainable income stream. Hence, we have a situation where demand for farm products has gone up and supply is erratic. The results are seen in constant price spikes for consumers and desperation for farmers who have been driven to extreme action at times when crops fail in the face of indebtedness. Under these conditions, there is the need to usher a new Green Revolution where we have a comprehensive package of quality of seeds, irrigation facilities, pesticides and fertilisers that is spread across the country and the crop spectrum. The funds have to necessarily emanate from the government if they are to come on a large scale as this is analogous to contract farming or corporate farming schemes, which however are restricted to the choice made by the company concerned. Assuming a cost of Rs 15-30,000 for a small pump set, the government could upfront provide the same to a fixed set of farmers every year. Providing 1 million such sets would amount to up to Rs 3,000 crore, which can be provided by the Budget. To make this work, there is of course the need to continue supplying free power to the farmers. The same could be done for seeds, fertilisers and say pesticides so that we are able to have a broad-based strategy for growth in agriculture. The basic point is that we need to provide the inputs gratis to the farmers if we are to encourage them to remain in business. MSPs and credit are only supplements that cannot solve the problem. More importantly, we need not always be reactive to agriculture as we are well aware of the cycles and amplitudes of farm growth. Planned growth in agriculture is doable and will eschew a crisis and hence be more pragmatic.