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RBI offers ‘indirect monetisation’ route to states to help with their stretched finances

The RBI’s decision to purchase state bonds in the secondary market through open market operations will provide a boost to the states’ finances at a time when they, just like the centre, are having to deal with a massive revenue crunch and rising expenditure commitments

October 09, 2020 / 07:37 PM IST

The Reserve Bank of India’s decision, on Friday, to purchase state development loans (or state bonds) in the secondary market through open market operations, will provide a boost to the states’ finances at a time when they, just like the centre, are having to deal with a massive revenue crunch and rising expenditure commitments due to the Covid-19 pandemic and an unprecedented economic slowdown.

“At present, SDLs are eligible collateral for Liquidity Adjustment Facility (LAF) along with T-bills, dated government securities and oil bonds. To improve liquidity and facilitate efficient pricing, it has been decided to conduct open market operations in SDLs as a special case during the current financial year,” RBI Governor Shaktikanta Das said after the meeting of the Monetary Policy Committee concluded.

“The OMOs would be conducted for a basket of SDLs comprising securities issued by states,” Das said.

The MPC kept repo rate unchanged, and for the first time this year, the RBI gave out GDP projections for 2020-21 and 2021-22. It expects real GDP for the current fiscal year to contract by 9.5 per cent, and rise by 10.1 per cent, primarily due to a low base effect, the next fiscal year.

“It is a welcome development. Given the current GST fiasco, it will help the states borrow at lower rates from the market. It is very good move,” said Soumya Kanti Ghosh, Chief Economic Advisor, State Bank of India.


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As per a report by CARE Ratings, for April 7-October 6, 2020, 28 states and two union territories have cumulatively raised a total of Rs 3.75 lakh crore via market borrowings, 55 per cent more than the borrowings in the corresponding period of 2019-20, which was Rs. 2.43 lakh crore.

“As per the borrowing calendar for the first 3 quarters of 2020-21 (April-December), the states are to borrow Rs. 5.07 lakh crore. States have already borrowed nearly 75 per cent of this amount,” the report said.

The report said that cost of borrowing for states continues to increase, even as they have been given permission to borrow more under the ‘Aatmanirbhar Bharat package’, and will have to take one of two options provided by the centre in the GST Council, further relying on market loans.

Analysts, including Ghosh, say that the RBI purchasing bonds through OMOs can be termed as ‘indirect monetisation’. The central banks has been active in purchasing central government bonds (g-secs), in greater volumes than any other year, thus helping keep the centre’s finances afloat. The same will now be done for the states.

RBI data shows that for the period of April 1 to September 13, 2020, the central bank purchased a staggering Rs 1.76 lakh crore worth of G-secs on the secondary market. This is more than three times the Rs 52,550 crore of G-secs that it bought in the same period last year.

Indirect monetisation is for now the plank on which the centre is maintaining its increased borrowing target of 12 lakh crore for the year, though direct monetisation cannot be ruled out.

Directly monetising the deficit is when the RBI directly purchases G-secs from the primary market to help the Centre’s expenditure. In turn, the RBI prints more money to finance this debt. Monetising the deficit was in practice till 1997, when it was discontinued by then RBI governor C Rangarajan.
Arup Roychoudhury
first published: Oct 9, 2020 01:17 pm
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