We feast on debt, and our kids will pay it back
PremiumPoor bank-deposit returns pushed people towards saving schemes used to finance the fiscal deficit
Good economics is not just about identifying the direct effects of policy decisions, but their indirect effects as well. Interestingly, an indirect effect of the Reserve Bank of India’s (RBI) monetary policy is clearly visible in the Union budget presented on 1 February.
The fiscal deficit for the current financial year 2021-22 has been revised to ₹15.9 trillion. When the budget for this year was presented last February, the fiscal deficit was expected to be at ₹15.1 trillion. The fiscal deficit is the difference between what a government earns and what it spends.
The government finances a bulk of its deficit by issuing bonds and borrowing money. In 2021-22, around ₹8.8 trillion of its borrowings are expected to be met by issuing bonds. This tells us that the total fiscal deficit is not just financed by bonds. The major other way is money coming into post office small savings schemes net of repayments. Every year, some investment made in past years by people in such schemes matures and that needs to be repaid . This year, the government expects around ₹6.8 trillion to be invested into these schemes. The redemption expected is ₹86,749 crore, which leaves around ₹5.9 trillion.
This ₹5.9 trillion will be used to finance the fiscal deficit. Hence, borrowing through the issuance of bonds and money invested in small savings schemes finances a large part of the government’s fiscal deficit.
This is where things get interesting. When the budget was presented last February, the government had assumed that around ₹4.8 trillion will be invested in these schemes during 2021-22. Further, ₹91,343 crore would be redeemed, leaving ₹3.9 trillion, which would go into financing the fiscal deficit.
Instead of ₹3.9 trillion, the government has ended up with ₹5.9 trillion, which is ₹2 trillion more. Why did this happen? The repo rate or the interest rate at which RBI lends money to banks was at 6.5% in January 2019. By February 2020, around the time the covid pandemic struck, RBI had cut it to 5.15%. By May 2020, the central bank had cut the repo rate further to 4%, which is where it has stayed since.
Before the pandemic struck, the idea was to push down interest rates so that people would borrow and spend more, and corporates would borrow and expand, thus helping the economy, which was going through a rather moribund phase. After the pandemic, the idea was to also help the government borrow at lower interest rates.
Along with cutting its key interest rate, RBI also printed and pumped money into the economy. Post-covid, bank lending growth collapsed, pushing interest rates on fixed deposits held with banks further down.
With a bulk of Indian household financial savings being in bank deposits, this hurt households and pushed them to search for higher returns. Stock markets beckoned. In 2019-20, on an average, around 420,000 demat accounts were opened every month. In 2021-22, this number reached 2.76 million demat accounts. A similar uptick has been seen even in case of mutual funds, through which people buy stocks indirectly. As the Securities and Exchange Board of India points out in its latest monthly bulletin: “On an average [2.39 million] new investor folios are being added every month."
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Everyone doesn’t want to take on the increased risk that stocks come with. Hence, many individuals have increased their investment in small savings schemes. While the interest rates on these schemes are lower than they were in the past, they are still higher than what bank deposits have to offer. This explains why the investment in these schemes has gone up dramatically this year and net of repayments is ₹2 trillion more than what the Centre expected.
This shows us the indirect effect of monetary policy and the impact that it has had on the Union budget. Low interest rates pushed people towards small savings schemes, which increased the total receipts of the government. Helped by this increase in receipts, along with an increase in tax collections, the government increased its expenditure for this year to ₹37.7 trillion against the ₹34.8 trillion it had budgeted for.
It doesn’t end here. There will be effects of this effect as well. As mentioned earlier, the money invested in small savings schemes matures over a period of time and needs to be repaid. It is repaid by using the fresh money being invested into these schemes in the year of maturity of past investments. In that sense, these schemes have a pyramid structure, where older investors are paid off using money brought in by newer ones.
This essentially means that future generations will pay for the expenditure of the current generation. Of course, all long-term government debt is like that. The trouble is that in tough times like these, considerations of inter-generation equity go for a toss.
As Arun Jaitley had said in his maiden budget speech: “Fiscal prudence to me is of paramount importance because of considerations of inter-generational equity. We cannot leave behind a legacy of debt for our future generations." But that is precisely what’s happening and the reason for that is simple: future generations don’t yet have a vote. They have to bear the cost of our free lunch.
Vivek Kaul is the author of ‘Bad Money’.
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