Why a high fiscal deficit can be bad for EMIs—BUDGET 2017

It is not for nothing that economists, policymakers and bankers will keep a close watch on what Finance Minister Arun Jaitley says about government’s borrowing intentions in Budget 2017-18. After all, what the government borrows has a direct bearing on how costly or affordable bank loans will be for households and companies. Governments, like individuals, cannot always meet the entire spending needs from its current income. While taxes and other earnings takes care of the bulk of the government’s  spending needs, very rarely does any major economy have surplus funds in its public coffers at the end of the year. Fiscal deficit broadly represents the amount of money that the government has to borrow every year to meet its expenses.  The government raises loans from the market by auctioning dated securities or bonds.  The Reserve Bank of India (RBI), as the government’s debt manager, conducts these auctions. The government also borrows money from individuals through a range of popular saving schemes. These include the post office savings account, national savings certificates and public provident funds Managing the government’s banking transactions is a key RBI role. The Centre, the state governments, companies and individuals all borrow from the banks’ same pool of lendable resources. A higher fiscal deficit would usually imply greater government borrowing. This, in turn, would mean the banks will have to set aside a larger slice of the available lendable resource cake for government loans. This will leave banks with less funds to lend to companies and households. A persistently high fiscal deficit carries the risk of government borrowing “crowding out” the private sector (industry and individuals) from the bank loan market. This could push up interest rates as companies and households jostle to borrow from a shrinking lendable pie. In 2015-16 banks lent Rs 72 lakh crore (about half of India’s GDP). Of this about Rs 4.40 lakh crore accounted were lent to the Centre. In the current year (2016-17), the Centre has lowered the market borrowing target to Rs 4.25 lakh crore, but more debt by states could affect the bank loan market. According to Japanese brokerage and research firm Nomura, states’ market borrowings will rise to Rs 3.5 lakh crore in 2016-17 from Rs 2.95 lakh crore in 2015-16. Besides, UDAY-related interest burden (special loan scheme for restructuring state electricity boards) and the implementation of the Seventh Pay Commission in most states by 2017-18 could push their borrowings higher to Rs 3.9 lakh crore next year. Greater government borrowing would leave banks with lesser funds to lend to the private sector, pushing up interest rates. RBI Governor Urjit Patel has cautioned that while since 2013, the central government has successfully embarked on a fiscal consolidation path, the general government deficit (borrowing by the Centre and states combined) is, according to IMF data, amongst the highest in the group of G-20 countries. “Borrowing even more and pre-empting resources from future generations by governments cannot be a short-cut to long-lasting higher growth,” Patel said in a speech delivered in Gujarat on January 11. Banks are currently flush with funds following the surge in demonetisation-induced deposits, but a jump in borrowing by states can offset the gains. States have pointed out that the economy-wide cash-crunch following the unexpected ban of Rs 500 and Rs 1000 currency notes in November has hurt their revenues. State governments say that demonetisation has curtailed consumer spending, affecting local tax collections and upsetting their fiscal plans for 2016-17. This could force them to borrow more.


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