question_answer

The increasing reliance of the Centre on small savings to finance the fiscal deficit is a source of concern.

The fiscal deficit is a little different from the rose, which, poetry tells us, is rose is a rose. An identical level of the fiscal deficit can have variegated impact on the economy, depending on how it is financed and how it is spent.

The spending part is easy to understand. If the borrowed money is spent on investment in new physical assets, it would have a multiplier effect on new income generation. If the borrowed funds are used to retire past debt, future interest outgo would come down but there would be no additional growth in the current time period.

If the funds are used to generate consumption, demand, underutilised capacity would be put to use, and, if there is not much underutilised capacity, fresh investment would be induced. The fiscal deficit has to be held in check because it represents the government’s claim on the non-government sector’s savings.

If the state borrows only what the nongovernment sector has to spare after meeting its own planned investment, there is no stress, but take away more than that, you end up with higher rates of interest, upward pressure on prices and a wider current account deficit.

However, all borrowing is not the same. When the government forces banks to lend to it, by mandating banks to hold government bonds as a high proportion of their total assets, the government borrows at a cheap rate but pushes rates sharply up for other borrowers. When the government borrows from the market, competing with other borrowers, the interest rate rise is shared by everyone.

But when the government borrows more than half its requirement from small savings, as it has this fiscal, it bypasses the market but makes monetary policy lose teeth. To draw savers, small savings offer high rates of interest.

This not just pushes up the government’s Interest costs but makes it difficult for banks to lower their deposit rates. If deposit rates hit a bottom, so do lending rates, whatever the Monetary Policy Committee decides. Then we cry about transmission loss in policy rate cuts.

From where has the government made maximum borrowings this fiscal?

A) From small savings

B) From large savings

C) From the market

D) Government has not borrowed this fiscal