A severe Siberian winter in 1972 devastated much of the wheat crop in the Soviet Union. The Soviets were eagerly looking to foreign sources to meet their large food deficit. Early that summer, they struck big grains for peace with America, agreeing to buy wheat from the US for many years. This is a valuable deal for the Richard Nixon administration, which is very tired of the Vietnam War and needs re-election. It was hoped that this would give American farmers some enthusiasm and reap the benefits of fat. The Soviets bought wheat worth at least $ 200 million a year for three years, not less than $ 750 million in total. For this, they also had access to private grain traders. U.S. Unbeknownst to the Americans, the Soviets had secretly split their purchasing teams, operating on the basis that everyone should know. Hotel rooms in New York, Washington and Chicago, through tough discussions in secret meetings with big private businessmen in the Soviets. Buyers purchased a quarter of 1972-73 US wheat production in forward contracts. They bought billions of dollars worth of grain in just one month. It was too late for the Americans to wake up.
Thanks to this great “grain exploitation”, the US (especially beef with low fodder) faced wheat shortages and high food inflation instead. Mark Penn signed the 1972 US-Soviet grain deal for the Nixon administration as the “Economic Bay of Pigs.”
Faced with severe food shortages, the Soviets planned a covert attack on world grain markets and procured adequate supplies to cover their deficit at very low prices. Is it possible for the Government of India, or its banker, the Reserve Bank of India (RBI) to do such a thing? Can India also launch a stealth attack and raise enough funds quickly to cover its huge fiscal deficit next year? The resemblance to wheat exploitation may seem far-fetched, but a recent title has given credence to it. Business Standard reported that the RBI scooped up “anonymously” ₹26,000 crore bonds in a single day. Recalling the Soviets, it seems that the RBI wants to get a very large size very cheap. Alas, we are no longer in 1972, and the markets today are very vigilant and omniscient. They know what happened and will not be on guard.
So, stealth options are over and there is no guarantee available on the size and price of the country’s deficit funds. However, there are still some unexplored and unusual options. The first is debt against shares.
India needs to take out gross loans for the next financial year, including state governments ₹23.3 trillion. Of these, only the center is counted ₹12.05 trillion. The Soviet “forward deal” to obtain cheap funds that would cover most of the deficit would be an agreement between the RBI and the center on bilateral debt-shares. It could bypass the credit market, with a reasonably low rate of 4%, and be in the nature of a five-year repo. The pledged shares must be returned within the same period or sold in dribbles. However, the Center is planning large-scale privatization of public sector entities. So, these loan-against-shares will increase future sales revenue for today’s use. (See ‘Outside Solution to India’s Stimulus Problem’, Mint, 5 May 2020). The estimated value of government holdings in the stock market and public sector companies is close ₹20 trillion. Periodic haircuts for slow-dropping sales or promised shares may be easier to implement as a privatization strategy.
RBI wants to buy government bonds anonymously to have someone’s cake. But you should not have both adequate funding and low costs for a program that takes out huge loans. This has been the case since 1997, when the government chose to respect market discipline over credit prices. If there is a shortage of funds, then interest rates should rise. As gross domestic product (GDP) growth is projected to double next year, the demand for non-government loans will be at least 12% of GDP, approximately ₹25 trillion, along with credit demand from the government. How can such a large demand sustain low prices, i.e. low yields on government securities? Even in America, where government borrowing is a very small part of its total debt demand, yields have risen slightly in recent weeks. Therefore, the second option is to allow the RBI to ensure yields to ensure sensitive bond auctions, without having to resort to anonymous attacks on the bond market.
The third option is to pay interest on the cash reserves of RBI member banks. The cash reserve ratio will soon be at 4%. Therefore, the RBI is almost locked ₹6 trillion bank money. Why not pay them interest on these funds at 3%? This will give additional revenue to the banks ₹18,000 crore, which will increase their capital base. It is like allocating a portion of the RBI’s balance sheet for the health of the banking sector, converting it into a central treasury as a general treasury.
The fourth option is to press foreign markets. Sell ’spice’ or dollar denomination bonds by proxy to a sovereign such as State Bank of India.
The center’s large financial deficit cannot be solved by theft or wit. This requires old-time market discipline, and requires slow and consistent chipping.
Ajit Ranade is the Chief Economist at the Aditya Birla Group.