Fiscal and Monetary Policies at X-Roads

While some leaders, particularly the politicians cutting across party lines, have been advocating that RBI should monetize the fiscal deficit of the government in order to pump in more liquidity into the system to propel the economic growth, several former RBI Governors and other economists have been advising both the government and RBI to be more cautious saying that such a step may lead to spike in the bond yields threatening the overall macro-economic and financial stability in the country. Monetizing deficit leads to RBI purchasing government bonds in the primary market and printing more money to finance this debt.

On 27th March, 2020 RBI had cut the repo rate from 5.15% to 4.40%, reverse repo rate from 4.90% to 4% and CRR from 4% to 3%. RBI, on 17th April 2020, has cut the reverse repo rate by 25 bps to 3.75%. On 22nd May 2020, RBI has cut the repo rate by 40 bps to 4.00% from 4.40% earlier and reverse repo rate by 40 bps to 3.35%.

These series of measures by RBI have led to:

(i) infusion of adequate liquidity into the system, and

(ii) reduction in the interest rates of banks.

However, after the collapse of IL&FS in 2018 NBFCs and small private banks have become extra cautious in lending. Consumer spending in Bharat declined for the first time in more than four decades in 2017-18, according to the survey conducted by National Statistical office (NSO). Unemployment rate of 6.1% in FY 2018 was the highest in 45 years as confirmed by both the Ministry of Statistics and Ministry of Labour

On 1st January, 2020 banks parked with RBI Rs. 41,214 crores under the reverse repo option which rose to Rs. 6,32,882 crores on 28th May, 2020 and Rs. 6,55,034 crores on 31st July, 2020! Whereas the annual growth rate of credit to the non-food sector shows a significant fall to 6.7% in FY20 – which is a 58-year low.

The above data clearly indicates that while RBI has been making best efforts to infuse adequate liquidity into the system and reduce the interest rates, which it has done successfully, the banks are not in a position to lend more to the borrowers due to various factors since 2019 and the Covid lockdown imposed since 24th March, 2020 has only added to the existing woes.

Declining revenue collections

The central Government originally estimated its central GST revenues during 2019-20 as Rs. 7.6 lakh crores that has been subsequently revised to Rs. 6.13 lakh crores whereas the actual collections during the year have been at Rs. 5.92 lakh crores.

The actual gross GST collection (domestic and import) during 2019-20 has been at Rs. 12,22,129 Crores registering a marginal growth of 4% over 2018-19. The constitutional guarantee provided to the states that their GST collection would grow 14% year-on-year poses a serious burden on the centre in the days to come.

A deeper analysis of the above data indicates the country is facing- decline in demand, increase in unemployment, reduction in GDP growth and significant downfall in the government’s revenue collections. Therefore, stepping up the government expenditure to arrest the declining economic trend will inevitably result in expansion in fiscal deficit.

Since the corporate sector has piled up inventories whereas the MSMEs and farming sectors have their own share of problems, expansion in the economic activity is possible only with a massive funding support by the government. Proper macro level planning backed by a strategic approach and effective monitoring of the implementation measures by the government will certainly give the desired results.

Linkage of economic activity and social sector investment with employment generation and demand growth are the key to the success of such macro level planning. In this context, the author proposes the following measures:

The Ministry of Statistics and Programme Implementation, that monitors infrastructure projects, has released its flash report for the Quarter ending December 2019. According to that report, out of 1701 infra projects worth Rs 150 crore and above, 401 projects reported cost overruns and 583 projects time escalation. The 401 infrastructure projects, each worth Rs 150 crore or more, have been hit by cost overruns of over Rs 4.06 lakh crore owing to delays and other reasons, according to the report.

“Total original cost of implementation of the 1701 projects was Rs 20,65,739.00 crore and their anticipated completion cost is likely to be Rs 24,71,954.78 crore, which reflects overall cost overruns of Rs 4,06,215.78 crore (19.66 per cent of original cost),” the ministry’s flash report said.

These projects are sponsored by the central government and spread across the states in the country in vital sectors like- roads, power, irrigation, sea ports, railways etc. The government can entrust the task of preparing an action plan to Niti Aayog to kick start these stalled and delayed projects with a strategic approach in a time bound manner in consultation with the states by giving priority to those projects that are close to completion but held up due to various reasons.

The works in these projects are executed either under EPC or PPP Models. While the government has a financial burden for EPC projects, the financial risk is borne mostly by the contractors under PPP Models with certain incentives or viability gap funding support assured by the government.

Most of the contractors executing these works (i.e., both EPC and PPP Models) are having financial stress due to the current market conditions and Covid has only added salt to their wounds. Therefore, the government and RBI have to prepare a policy note to direct the banks with necessary guidelines to fast track the process of restructuring the loan accounts and give additional bank credit to these contractors. This will help in revival of the activity takes place in those stalled and delayed projects at an early date.

As and when the contractors submit the bills to the government under EPC models on completion of the works as per the terms of the contract in a phased manner, the banks have to be directed to finance those bills and release the funds to the contractors without recourse to them so that the ultimate payment obligation remains with the government.

Considering the delay in releasing the payments by the government, these bills financed by the banks, may be with a tenor of 180 days and the interest on this bill portfolio may be recovered from the government on quarterly basis so that the contractors are totally relieved from the burden of both interest payment and principal repayment. This is because this financing is done by the banks without recourse to the contractors who have executed their performance obligation as per the contract terms and the ultimate payment is due from the government.

This mechanism will not only enable the government to kick start the stalled and delayed central government sponsored projects across the country but also provide elbow room to the government to mobilize the funds in a phased manner. A special task force may also be formed to ensure that the required approvals and clearances for these projects are obtained on fast track from the concerned ministries/ departments.

This strategic approach towards the revival of the activity in stalled and delayed projects will lead to creation of large number of jobs to the construction workers across the country and pick up in the demand for steel, cement and other construction material and equipment. This in turn will lead to expansion in the activity in those sectors and job creation in these sectors that will have multiplier effect.

The twin problems of growing unemployment and declining demand can be arrested with this strategic approach. This strategic approach in the medium and long run will lead to the revival of economic activity in both corporate sector and MSMEs.

Further aligning this strategic approach in revival of stalled and delayed projects by establishing linkages with rural infrastructure like- construction of village roads and warehouses with cold storage facilities, irrigation projects etc., will lead to improving the rural supply chain, reducing the storage and transportation losses, particularly for the fruits and vegetables and improving the incomes to the farmers.

Hope the government and the banking regulators would collectively evolve a strategic plan of action to steer the Indian economy from the troubled waters and sail through smoothly to reach the developmental goals.


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About the Author

Dr. B.N.V. Parthasarathi
Ex- Senior Banker, Financial and Management Consultant and Visiting faculty at premier B Schools and Universities. Areas of Specialization & Teaching interests - Banking, Finance, Entrepreneurship, Economics, Global Business & Behavioural Sciences. Qualification- M.Com., M.B.A., A.I.I.B.F., PhD. Experience- 25 years of banking and 14 years of teaching, research and consulting. 100 plus national and international publications on various topics like- banking, global trade, economy, public finance, public policy and spirituality. One book in English “In Search of Eternal Truth”, two books in Telugu and 20 short stories and 27 articles published in Telugu. Email id: [email protected]