The finance minister has done well to respond to the criticism that followed his Budget presentation last week, specifically that he had not emphasised economic reforms. Pranab Mukherjee has now clarified that the government does intend to undertake disinvestment in state-owned enterprises during the year. On the second major point of criticism, with regard to the government’s large borrowing programme, Mr Mukherjee has told Parliament that he will avoid raising interest rates and crowding out private borrowers; he has also said that he will not monetise this year’s large fiscal deficit; the open market operations (OMO) that the Reserve Bank will be expected to undertake, he has said, should not be confused with monetisation.
With due respect to Mr Mukherjee, OMO (which is short form for RBI selling and buying government securities) usually means monetisation. If RBI sells securities to banks and other institutions that take part in the government debt market, it takes in money and reduces liquidity in the system. If it buys securities, it gives out money and adds to liquidity—and net RBI credit to the government goes up as a consequence. This is also what would happen if the government issued securities directly to RBI (which, in the Indian context, has been the narrow definition of monetisation). Globally, OMO is certainly understood to be a method of monetisation. The only advantage over direct placement (which the fiscal responsibility law of 2003 forbids, except under exceptional circumstances) is that OMO has a process of price discovery and therefore puts a market-determined price on government securities. To that extent, it is superior to private placement, but the monetary impact of the two courses of action is exactly the same.
The issue becomes clearer when viewed against the scale of RBI’s OMO in past years, which was minuscule when compared to the Rs 200,000 crore that is proposed for the current year. The net impact of this will be an increase in money supply by more than 3 per cent of GDP, and is by definition inflationary unless there are countervailing forces at work (such as a net outflow of dollars).
However, now that the disinvestment programme has been put firmly on the table, it should neutralise Rs 40,000 crore of one-time expenditure this year on the farm loan waiver and Pay Commission arrears, which is one of the reasons given by Mr Mukherjee for the large borrowing programme. That could bring down the deficit to lower than last year’s 6.2 per cent of GDP. The minister has also mentioned a potential safety hatch in the form of the revenue buoyancy that will flow from switching next year to the integrated goods and services tax. Such a pay-off is indeed on the cards because of increased tax compliance, and is one of the major arguments in favour of the GST. The concern that experts have voiced is the lack of sufficient preparatory work so far, including in Mr Mukherjee’s Budget. In the next nine months, the finance minister must get a Constitutional amendment passed with the required majority in both houses, and then adopted by at least half the states, even as the rest of the preparatory work goes on.
