This is a difficult year; and the coming budget is even more difficult. For a Finance Minister, his job will be easy when revenues are coming. You can guess the status of Ms Nirmala Sitharaman as the nation’s largest tax resource – the Corporate Income Tax itself is short of nearly Rs 1.45 lakh cores.

How the government is doing its rescue work when the economy is going through the lowest growth in the last two decades?

Certainly, given the deep slowdown, budget 2020 is going to be keenly observed as a Government’s mission exercise to stimulate the economy. A passive government, doing normal budgetary delivery is not expected this time. That also from a government which enjoys huge mandate should make some extra step.

Now, the question is straight. Whether the government will customise its action in the budget by tightening its belt, thereby adjusting falling revenue in the budget? Or whether the government will show some grit to spend more even if there is starvation?

Economists are divided on the question.

Still two policies undertaken by the RBI in the recent past shows that the government is ready for a kill. It may even stretch the fiscal deficit to 4 to 4.5% of GDP to stimulate the economy. Even if the borrowing size goes to some Rs 10 lakh crore figure, there is no need for surprise.

RBI’s Operation twist and enhancing of FPI limit in government bonds

So, when we are examining the past macroeconomic engagements of the government and the RBI, there is ample proof that this budget is going to be expansionary.  Of these, two extraordinary actions by the RBI are noteworthy.

First is the RBI’s operation twist where the central bank purchased large volume of government securities.

Second, the RBI also enhanced FPI limits in government securities from 20% of the total securities issued to 30%. The RBI also doubled voluntary retention route in government securities for FPIs.

Operation twist was a surprising and non-conventional intervention made by the RBI, to bring down long term government yield. The central bank bought long term government securities (bonds) while selling short term securities. This in turn has reduced the long-term yield of government bonds. Implication of such a step is that government can sell its bonds at a relatively lower rate (interest) in future.

When the government is selling huge volume of bonds (as a result of high fiscal deficit), the interest rate or yield will increase. Since the yield is calmed due to RBI intervention (operation twist), the government can issue new bonds to cover fiscal deficit at a comfortable situation after the budget.

RBI has made three Open Market Operation for operation twist. As a result, yield on government bonds declined. Hence, the RBI conditioned the bond market situation and the government can make large volume of bond selling to finance the budget.

In another policy, the RBI raised FPI investment limits in government bonds from 20% of the value of whole bonds to 30%. This will increase more investor participation in the government securities market. Higher the number of participants, lower will be government’s pain to sell its bonds in the market.

In the case of FPI investment in government securities, the RBI doubled FPI investment through voluntary retention route.

The two actions by the RBI will make it comfortable for the government to sell its securities even if there is higher fiscal deficit. In pervious years, the government borrowed money to finance nearly 66% of its fiscal deficit. Remaining portion of the fiscal deficit (borrowing) were financed through sourcing funds from government’s own institutions like small savings, PPF, LIC etc.

Interestingly, what will be the size of excess expenditure that is going to make this budget expansionary. Remember that the government’s standard is the FRBM target of 3%. But in this difficult year, it is difficult to stick on the fiscal deficit target. During 2008-09 also the then FM Pranab Mukherjee made exorbitant spending.

Under the current situation, a borrowing or fiscal deficit may go up to 4 to 4.5% of GDP ore even higher.


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