The six-member Monetary Policy Committee was divided in its view of fiscal slippage and its impact on inflation trajectory. While the inflation trajectory has been within the central bank’s comfort level prompting every MPC member vote unanimously for 25 basis points policy rate cut in June, any disruption on prices may change the way MPC members see possibility of further rate reductions.
Minute of the June MPC meeting showed that two members including deputy governor Viral Acharya flagged off concerns over upside risk which was downplayed by the Governor.
“Government securities are typically funded by bank liquidity, whereas PSU bonds are financed by a leverage on bank deposits. This does not impact either banks’ deposits, asset books or money market liquidity,” BofAML said in a note, in support to Governor Das.
The firm explained that when a bank bids in a g-sec auction, it has to carve the investment out of its loan or investment book. As the money flows to the government account with the RBI, money market liquidity shrinks. On the other hand, when public buy a quasi g-sec or PSU bond, funds flow from fixed deposits to the PSU’s current account.
“Public sector borrowing includes several public sector enterprises which have their own revenue streams to service their debt and take care of their liabilities. Borrowings by such public sector enterprises are mostly for capital expenditure. Hence, such borrowings should be viewed differently,” Governor Das had said.
Deputy Governor Viral Acharya had opined that public sector borrowing impairs monetary policy transmission due to crowding out effects on market financing through public bonds and on bank deposits through small savings which continue to offer rates that are significantly higher than market yields. This channel bites particularly when the domestic savings rate is on a decline and increases economy’s reliance on external sources of funding.
“We do not agree with conventional wisdom of adding up the government’s issuance of g-secs and quasi government borrowings to measure crowding out, as they have very different liquidity effects,” BofAML said.
Among MPC members, Ravindra Dholakia supported the Governor while Chetan Ghate has shown concerns over fiscal risks. Pami Dua and Michael Patra did not mention anything on fiscal risks.
“There’s has been growing divergence within the MPC on whether higher fiscal deficit (public sector borrowings) will result in higher inflation. MPC is also split on whether the rise in food inflation will sustain. Governor Das is not worried on either counts,” Nomura observed.