How government’s extra Rs 4.2 tr ln borrowing will affect you

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TradingFunda

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The government today said that it will borrow an extra Rs 4.2 lakh crore during this fiscal. Initially, its gross borrowing target was Rs 7.8 lakh crore. That has now been increased to Rs 12 lakh crore.

Here are the answers to some of the key questions you may have about the government’s borrowing program and how it affects various stakeholders.

Why do governments borrow?
Governments like companies always spend more than they earn via taxes. The assumption is that, if the government invests in education, health and infrastructure, it will improve productivity and boost economic growth. This should more than pay for the debt the government has incurred.

Is high government borrowing necessarily a bad thing?
It depends on how high. If the annual interest rate the government is paying on old debt is higher than the rate of growth in revenue, that’s bad. You are then borrowing more to pay old debt.

High debt is not bad provided it is accompanied by high growth. Thus far, India’s combined state and central fiscal deficit has been higher than that of other countries’ rated BBB-. But our deficit is tolerated, since no other country in this BBB-category can boast of a 10 percent plus nominal GDP growth. In the 2000s, nominal GDP growth was 14-16 percent.

Why is the government's borrowing figure closely watched by the bond and equity markets?
All corporates bonds, all interest rates are priced higher than the interest rate paid by the government. The sovereign pays the least rate of interest because she can’t default, she can print and pay. Now, if sovereign borrowing is too high, buyers of government bonds will want a higher rate of interest. If the yieldS on government bonds go up, cost of debt or cost of capital goes up for everyone. So higher sovereign borrowing is not welcome unless it is spent so wisely (like bank recapitalisation or highway construction) that productivity and tax collections go up.

Why is the government borrowing Rs 4.2 lakh crore more?
Economists say the shortfall in tax revenues this year for the government will be almost 1 percent of the GDP, due to weak economic activity. Assuming the GDP is flat at Rs 200 lakh crore (Rs 200 trillion), the tax shortfall is Rs 2 lakh crore. The government budgeted a divestment income of Rs 2 lakh crore, which looks tough in this risk averse milieu. So the Rs 4.2 lakh crore excess borrowing is expected to just about meet revenue shortfall.

What implications does this have for the...

Economy
It depends on the support that RBI extends to the government’s borrowing programme. If RBI buys some of the bonds issued by the government, the economy will be benefitted as interest rates will not rise. But if the economy does not grow, the excess money sloshing around in the system can cause inflation.

Corporates
Likewise. If the RBI supports government borrowing, corporates will be less hurt by a rise in cost of borrowing. Also, companies will hopefully get their dues from the government. Right now the government is postponing legitimate payments due to the private sector.

Consumer
Don’t expect a steep fall in the home loan and other rates, provided you have the courage to take a home loan. But if you have a secure government job, it is a good time to take a home loan. Pensioners could hurt if inflation rises going forward.

Bond market
With RBI support, yields on government bonds will stay at 6 percent for 10-year bonds. Without RBI support, yields can rise to 6.5 percent or even 7 percent

Stock market
May sulk, as the extra Rs 4.2 lakh crore just about makes up for tax shortfall. The borrowing figure does not pencil in any stimulus, which the market is eagerly looking forward to.
 
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