Going For Broke, Again

Cut it to contain inflation, which the Congress has identified as the key pre-election economic issue. And have it, because the Government cannot contain its pre-election profligacy directed towards image-building welfare programmes. Sandwiched between its paradoxical ambitions have been the public sector banks which are being pressured to buy Government securities and give the Rao administration liquid cash. And reeling in the wake of the issue devolvements is the Reserve Bank of India (RBI), since it has had to pay up the shortfall to the Government. Which has been to the extent of about 50 per cent of the three issues: Rs 712 crore in the 14-per cent 2005 issue on November 27, Rs 982 crore in the floating rate bond offer on December 5, and now Rs 960 crore.

The three knocks underscore how stretched North Block’s imagination is, if it   thinks it can hit pay dirt by using ‘moral suasion’ to funnel money from the banks to its own coffers. Even if it owns the banks.

Why aren’t banks picking up Government paper, in spite of it being ‘safe as gold’, and given the fact that at about 14 per cent, the interest rate being offered is getting closer to the market rate, as is expected of a liberalisation programme? The problem is that the rate is not high enough even as it reflects the desperation of a government famished for funds. "Last year, despite low statutory liquidity ratio (S L R) requirements (banks meet a large extent of the S L R requirements by holding Government paper), banks were going in for Government securities but now the demand for industrial credit has picked up. So, it is definitely better to opt for credit than securities," says Bandi Ram Prasad, chief economist, Indian Banks’ Association. According to the Centre for Monitoring Indian Economy (C M I E), banks’ investment in securities in the first half of 1995-96 at Rs 8,291 cro re was about half of  that in the corresponding period last year.

Not surprising. Says S. Venkitaramanan, former RBI governor: "The treasury bills issue was expected to be a flop because the country’s economy is not in a position to finance the huge fiscal deficit. With the accent on inflation control, our government is scared to monetise (that is, issue money to cover the deficit), but apart from monetisation there is no other way to make this problem less intractable." The most conservative estimate of the fiscal deficit is about Rs 56,000 crore.

A greater dependence of the cash-strapped Government on ad hoctreasury bills (loans at 4.6 per cent from the R B I) has been clearly visible, in spite of the Finance Ministry ’s surprisingly well-meaning agreement with the central bank to phase these out by 1997-98. For 1994-95, the Government entered into an under-standing with the R B I to limit its borrowing to Rs 6,000 crore over the year, and not exceed Rs 9,000 crore for more than 10 continuous working days. The Government had crossed the limit several times during the year. The net increase in R B I credit to the central Government was Rs 13,225 crore between March 31 and September 15.Thus, borrowing from the R B I now is a harder option to tap. Especially since by increasing the money supply, it defeats the greater objective of controlling inflation.

The low in the stockmarkets, which saw the bombing of the public sector units’ Rs 7, 000 - crore disinvestment programme  three months ago, leaves the Government with only one choice: turn to the public sector banks. It is, then, likely to continue its borrowing - from - the - banks spree with another Rs 9,000 crore slated to be raised in the current year, though this suggests another row of devolvements on the R B I. It will leave in its trail a much poorer banking system. "Since the banks are owned by the Govern-ment, the pressure can work," says D.H. Pai Panandikar, director general, R P G Foundation.

How did the Government’s pockets get to be so hungry? Or to be more precise, what made it stoop to helping itself so much from the banks’ reserves? A look at the trends in the Government’s expenditure and revenue: the gap between the total outlay and current revenue, which is fed by the internal and external borrowings and the budget deficit, is widening. "The non-development expenses are rising too rapidly in relation to the current revenue. The bulk of the revenue goes simply into paying interest," says Arun Kumar, associate professor, Jawaharlal Nehru University. Interest payments form the single largest component— more than 50 per cent— of the non-development expenses. And they are rising fast. Total paybacks for the central and state governments polevaulted 116 per cent, from Rs 25,006 crore in 1990-91 to an estimated Rs 54,044 crore in 1994-95. It is easy to see how the Government can jaywalk straight into a debt trap. The more the Government borrows, the more it has to pay in interest, and if the borrowing is not used for productive purposes, enough is not earned to pay interest.

On the flip side, revenues are on the way up. Tax collections shot up by 23 per cent to Rs 46,690 crore during the first half of the current fiscal year— way above the 15 per cent increase budgeted for the entire year. Direct tax collections are likely to exceed the target of Rs 32,000 crore for the year. But, if this is good news, it’s definitely not good enough. Says Kumar: "Although tax revenue is increasing, it is not as much as it should have been. The tax to GDP ratio has come down because of reduced tax rates in the new economic policy. The black economy is substantial. Even as business income is growing by 50-60 per cent, the income and corporate taxes are rising by only 35 per cent." S.B. Gupta, professor, Delhi School of Economics, had estimated the parallel economy to be 55 per cent over the white in 1987-88. "In which case, if the black economy were to  be tapped also, at the current rate of taxes, direct taxes alone would have roped in Rs 3 lakh crore— about 10 times the target," says Kumar.

So the Government needs cash urgently, but the opportunity cost incurred by the banks by lending to it is high. With the deregulation of interest rates for deposits of maturity of two years and above, some banks are offering 12.5 per cent interest per annum, that is, they are borrowing at this rate. After meeting the S L R requirements laid down by the R B I, they are then lending to industry at 17-18 per cent, sometimes even higher. S L R determines the proportion to be invested in Government securities and the long-term policy is to bring it down. And banks have actually invested in Government securities— which offer 12-13 per cent on an average — already in excess of the S L R level the S L R level which now stands at 29.3 per cent. "This additional amount could instead be lent to the commercial sector, and the banks are losers to that extent," says Panandikar. And also, the economy.

For, the loss magnifies as it shifts to industry— the next link in the vicious circle. Corporate sector borrowers— excluding the ones from priority sectors such as the small-scale and retail trade which have to be given 40 per cent of the credit by the banks— are the ones the Government is nudging out. "Deposit mobilisation is growing slower this year," points out K. Krishnamurthy, professor, Institute of Economic Growth, and this is a poor match for the surge in corporate demand for funds. According to the CMIE, the annual growth rate in bank deposits, which peaked at around 22 per cent in November 1994, fell to just 12.6 per cent by September 1995. There is a diversion of funds by the public from the banking system towards higher - yielding instruments such as mutual funds. The situation has worsened with the reduced growth of foreign capital inflows.

With the stockmarkets damp, and the external sources no better (of the 60 Indian companies which issued global depository receipts, those of only two have been at a premium), industry is depending more on the banks. But in spite of the increase in deposit rates following the busy season credit policy, the system is hardly equipped to sustain the 10 per cent industrial g rowth rate. And making the credit crunch look larger than life is increased speculative activity fuelled by the political uncertainty in the country. "People are holding on to liquidity, and getting into speculation, for instance, in the forex market," says Kumar.

The RBI, on its part, has tried to provide some relief by steadily slashing the SLR and the Cash Reserve Ratio (CRR) requirements. The CRR has been brought down— in two stages— from 15 to 14 per cent, between November 11 and December 9. The CRR on old Foreign Currency Non-Repatriable (B) deposits up to November 24, has been reduced from 14.5 to 7.5 per cent. These measures will release Rs 5,050 crore into the system. But much of this money may have been sucked out of the industrial system by advance tax payments which fell due on December 15.

The other piece of good news according to the Government is that the inflation rate slumped to an 118-week low at 6.93 per cent, for the week ended December 9, the lowest since the 6.6 per cent level of August 27, 1993. Few observers, however, are enthused. "It is not the right way of calculating. The current provisional figures, instead of being matched against last year’s provisional figures, are compared to the final figures of last year, which are normally higher than the corresponding provisional figures, so you get a lower inflation rate," points out Panandikar. Moreover, while the wholesale price index may be moving at 7-8 per cent, the consumer price index is moving much faster at around 11.9 per cent. Let alone the figures, just ask a commoner. "The steepest price rise in the last five years has been in food," says Kumar.

While the Government, by restricting the money supply, intends to check inflation, it could also lead to a slowdown in production. "Investment in fixed assets and inventories will suffer," says Panandikar. If that happens, the obvious fallout will be money chasing fewer goods, and a hike in prices. Did the Government say it was trying to curb inflation?

The escape route from the vicious loop should come in the form of a cut in wasteful expenditure, but the Government seems in no mood for it. "This year being the election year, nothing is possible," dismisses Krishnamurthy." To the Government today, goodwill expenditure is important, even if it is at the expense of industrial investment in the country," adds Panandikar. Kumar stresses that "the crux of the matter lies on the revenue side, not expenditure." But tapping the black economy needs much stronger political will than has been in evidence. The most practical way out, then, may be to monetise. Better today, for with the interest rates still higher, the Government may find itself in a bigger mess tomorrow.

And the bottomline? Call it dejavu. With the 1991 International Monetary Fund (I M F) programme coming to an end in 1997, India may be ready for yet another IMF-guided fiscal stability programme. The country will have then come a full circle or in linear-speak, travelled six years back in time. Like the proverbial bad penny, old spectres might return in the form of a repeat of the 1991 crisis.