Covid-19 crisis: Budget blowout may see RBI resort to direct financing

The government is facing a Budget deficit of as high as 7 per cent of gross domestic product, the widest in more than two decades, according to some estimates.

The central government is running out of options to fund its Budget and may soon have to knock on the central bank’s door once again for support.

The administration can get the Reserve Bank of India (RBI) to buy sovereign bonds directly or boost dividends to help supplement revenue, which has been hit by an economy-crippling lockdown to contain the virus’s spread. The government is facing a Budget deficit of as high as 7 per cent of gross domestic product, the widest in more than two decades, according to some estimates.

It would “make sense to go for some form of deficit monetisation” right away, said Sabyasachi Kar, RBI chair professor at the National Institute of Public Finance and Policy in New Delhi. “Demand creation can only happen if the government spends.”

Central banks from the US to Japan are helping to fund record fiscal stimulus from their governments amid the pandemic. That’s even been the case in emerging markets like Indonesia — where the central bank this week agreed to buy billions of dollars of bonds directly from the government. The approach though carries risks for developing economies, especially for inflation, the currency and the independence of the central bank.

The Fiscal Responsibility and and Budget Management Act prevents the RBI from buying bonds directly from the government in the primary market, but the law provides an escape clause in the event of the country facing a national calamity or a severe slowdown.