A harsh Siberian winter in 1972 destroyed much of the wheat crop in the Soviet Union. The Soviets were interested in foreign sources to fill their large food deficit. By early summer, they had signed a major grain-against-peace deal with America, agreeing to buy wheat from the United States over several years. This was a valuable deal for the Richard Nixon administration, very tired of the Vietnam War and in need of re-election. It was expected to bring joy and bring big profits to American farmers. The Soviets had been “twisted by the arm” in an assured purchase of at least $ 200 million in wheat a year over three years, with a cumulative total of as much as $ 750 million. For this, they also had access to private grain traders in the United States. Unbeknownst to the Americans, the Soviets secretly divided their purchasing teams, each working on a need-to-know basis. Through difficult negotiations in secret meetings with large private traders held in New York, Washington buyers bought a quarter of United States wheat production from 1972 to 1973. They bought $ 1 billion worth of grain. in just a month. By the time the Americans woke up, it was too late.
Thanks to this great “grain theft”, it was rather the United States that faced a shortage of wheat and high food inflation (especially beef because the feed for cattle was lacking). Mark Penn called the 1972 Soviet-US grain deal an “economic berry of pigs” for the Nixon administration. It’s another matter that Nixon won the White House by a landslide.
Faced with a severe food shortage, the Soviets planned a sneak attack on world grain markets and secured sufficient supplies to meet their deficit at a very low price. Is it possible for the Indian government, or its banker, the Reserve Bank of India (RBI), to do something similar? Can India also launch a sneak attack and quickly raise enough funds to fuel its monstrous budget deficit next year? The Wheat Heist analogy may seem far-fetched, but a recent headline makes it plausible. Business Standard reported that RBI had “anonymously” recovered ₹26,000 crore of bonds in a single day. It seems that RBI wants to secure a very large quantity at a very low price, reminiscent of the Soviets. Sadly, it is no longer 1972, and the markets are much more vigilant and omniscient today. They know what’s going on and won’t be caught off guard.
So the stealth options have come out, and there is no assurance available on the amount and price of the country’s deficit financing. However, there are still unexplored and unorthodox options. The first is a loan for shares.
India’s gross borrowing requirement for the next fiscal year, including that of state governments, is approximately ₹23 300 billion. Of this amount, the Center alone will represent ₹12.05 trillion. A Soviet-style “term deal” for cheap financing, which will fill much of this gap, would be a bilateral equity-for-loan deal between the RBI and the Center. It can bypass the debt market, be priced at a reasonably low rate of 4%, and be in the nature of a five-year repo. Pledged stocks should be returned or sold in dribbles over the same period. In any case, the Center is considering large-scale privatization of public sector entities. So this equity loan would simply advance the proceeds of the future sale for today’s use. (See “A Ready-Made Solution for India’s Stimulus Problem,” Mint, May 5, 2020). Given a stock market euphoria, the estimated value of the state’s holdings in public sector companies is close to ₹20,000 billion. Slow sales or periodic discounts on pledged shares might be easier to implement as a privatization strategy.
The anonymous purchase of government bonds by the RBI is like wanting to have your cake and eat it too. But you cannot have both sufficient funds and low costs to support a massive borrowing program. This has been particularly the case since 1997, when the government chose to respect market discipline in debt pricing. If there is a lack of funds, then the interest rates must go up. With double-digit gross domestic product (GDP) growth expected next year, demand for non-government credit will amount to at least 12% of GDP, or around ₹25 trillion, in addition to the government’s demand for credit. How can such high demand support low prices, i.e. low yields on government securities? Even in America, where even the most inflated government borrowing represents a much smaller fraction of its aggregate demand for credit, yields have risen dramatically in recent weeks. Therefore, the second option is for the RBI to let yields rise to ensure smooth bond auctions, so that it does not need to resort to anonymous raids in the bond market.
A third option is for the RBI to pay member banks interest on cash reserves. The cash reserve rate will soon be 4%. So RBI will almost close ₹6 trillion money from the banks. Why not pay them interest on those funds at, say, 3%? This will give banks additional income of ₹18,000 crore, which would strengthen their capital base. It would be like allocating part of the RBI’s balance sheet to the health of the banking sector, rather than returning it to the central treasury as a general dividend.
The fourth option would be to tap foreign markets. Sell either “masala” bonds or dollar-denominated bonds through a sovereign agent, such as the State Bank of India.
The Centre’s large budget deficit will not be tackled by stealth or intelligence. It needs old-fashioned market discipline and a slow and steady reduction in it.
Ajit Ranade is Chief Economist at Aditya Birla Group.
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