How the Centre should spend the bonanza from RBI - Hindustan Times
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How the Centre should spend the bonanza from RBI

ByMonika Halan
May 24, 2024 11:06 PM IST

The new government would be wise to prioritise reducing fiscal deficit with the surplus dividend from RBI. Spending, if any, from this amount should be on capex

Suppose you have a sudden inflow of money. A bonus at work, a tax refund or an inheritance that gives you a one-time boost. As an individual, you have three decisions in front of you — spend it, pay off your debts, or invest it. Smart people would use a mix of the three options, prioritising the paying off of debt. Governments, too, have the same choices when faced with a sudden money boost. The extra trillion of surplus that the Reserve Bank of India (RBI) has transferred to the government will allow the government, formed after the elections, to decide what path it wants to tread. A fiscal-prudence-plus-investment road is good for the long-term health of the country, a populist spending splurge or redistribution urge will be as harmful as a rich dad buying a Porsche and allowing an underage kid to drink and drive.

RBI. (HT PHOTO) PREMIUM
RBI. (HT PHOTO)

RBI recently created headlines as it announced a transfer of 2.11 trillion to the government, almost double the amount estimated in the 2024 interim budget. How did RBI get this extra money? While RBI has not given a reason in its May 22 press release, in which it announced the decision taken at the 608th board meeting to transfer the higher-than-anticipated amount, we can make some guesses. The biggest reason could be the rise in interest rates on United States (US) treasuries. RBI holds a mix of US government bonds and dollars as a “reserve” or safety money. The World Economic Forum lists seven reasons why countries keep foreign (mainly US) currency and bonds as reserves, including having liquidity for international transactions, as a hedge against any domestic economic crisis, and to reassure foreign investors. This reserve is mainly held both as dollars and as US government or US treasury bonds.

As of March 31, RBI held 4.74 trillion of foreign currency assets. RBI’s earnings from its US treasury holdings must be up on the back of rising interest rates in the US. These rates have gone up from a low of 0.52% on August 4, 2020, on the 10-year US treasury, to 4.20% on March 22, 2024, resulting in a big hike in interest income for bondholders. There has been some speculation that the government “arm-twisted” RBI into this higher transfer or forced it to take too much risk. A retired senior official of RBI rejected the idea outright and agreed with the higher-interest income line of thought.

Whatever the reason, the extra trillion of cash gives the government that comes to power in June options to spend, invest or pay off its debts — choices similar to what we face as individuals. The first impulse when faced with a sudden inflow of money is to spend. And had this infusion come a year earlier, the temptation for a freebie splurge in a pre-election year might have been high. But whichever government comes into power in June, need not splurge this windfall for political benefit as elections will be half a decade away.

The second option will be spending on capital expenditure — or building assets that give future revenue. This will be like buying a flat in anticipation of future rental income or investing in a business that yields income and profit. The government has pushed the envelope on capital spending in the last few budgets and the benefits are beginning to be seen in the growth numbers. We could see some small boost to the capital spending over what was budgeted in the 2024 interim budget.

The last, and most favoured, option is to reduce the fiscal deficit (the excess of spending over income of the government) that has been projected to fall from 5.8% to 5.1% of the Gross Domestic Product (GDP) in FY25 over the previous year. Think about it from the point of view of your own finances — a large loan makes your personal finances precarious and a sudden job loss or emergency can derail your life. While the government can always print more money and sell assets to bridge the gap, a lower deficit number has a number of positive reactions in the economy.

One, it reduces the amount that the government has to borrow putting pressure on interest rates to fall. Lower interest rates boost borrowing by both individuals and firms to fund investment. Which, in turn, is positive for growth.

Two, lower government borrowing also leaves more aggregate savings to be available for the private sector for investments. The private investment cycle is yet to take off in India and a lower interest rate regime plus availability of savings are important factors in this journey.

Three, it gives a good signal to the foreign rating agencies on fiscal prudence. India’s global investment ratings are important as they affect the flow of money from foreign investors into the country. Foreign money is important as it bridges the savings gap.

Four, a lower deficit is also a dampener on inflation as the government borrows less and does not need to print money to bridge the deficit.

Of course, the spend will need to consider that this is a one-time boost and not build in recurrent expenses on the back of this infusion. The full Budget announcement in July will show us the path that the newly elected government will take. We can only hope that the road of fiscal prudence is followed rather than a short spin in a fast car.

Monika Halan is the author of the best-selling book Let’s Talk Money. The views expressed are personal

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