Reserve Bank financing of government to fall: Goldman Sachs

March 30th, 2009 - 2:57 pm ICT by IANS  

New Delhi, March 30 (IANS) The central bank has some leeway in funding the government due to a buffer it has built up over the past several years, but this could get exhausted rather quickly, global investment bank Goldman Sachs said in a report released Monday.
“Our calculations show that the RBI (Reserve Bank of India) can fund about Rs.1.5 trillion ($30 billion/Rs.1.5 lakh crore) of the government’s borrowing needs without creating a sizeable monetary overhang and stoking inflation,” it said.

“However, given the size of the deficit, this would still require the market to absorb more government bonds than in FY07 and FY08. Further, this would leave the RBI with little space to finance the government beyond FY10. Therefore, we think long-term government bonds may remain under selling pressure,” Goldman Sachs cautioned.

It noted that broad money supply growth rose to 19.7 percent year-on-year March 13, from 19.6 percent in the previous week, “due to increased lending to the government”, even as growth in lending to the commercial sector and net foreign exchange assets continued to fall.

Wholesale price index inflation fell to 0.27 percent in the week ending March 14 from 0.44 percent the previous week, “leading to concerns about deflation approaching”.

On the liability side, growth in base money has “fallen dramatically” to about 4 percent March 20, from 28 percent year-on-year a year earlier, Goldman Sachs said.

“The largest contributor to the decline is a fall in bank deposits at the RBI. Growth of currency in circulation has also declined somewhat from about 22 percent y-o-y in end-October to 16.6 percent y-o-y in the latest reading.”

Goldman Sachs, assuming that RBI’s credit to the private sector would grow in the long-term and that foreign reserves would be stable, calculated the apex bank’s possible expansion in credit to the government to be about Rs.1.5 lakh crore.

Taking note of the RBI announcement last week that it would purchase Rs.80,000 crore ($16 billion/Rs.800 billion) in government bonds in the first half of 2009-10, it said: “Even with the additional headroom for the RBI, it leaves about Rs.2 trillion ($40 billion/Rs.2 lakh crore) to be financed by the market, which is higher than the government’s market borrowings in FY07 and FY08.”

According to Goldman Sachs, if RBI chose to purchase more government securities to contain the increase in bond yields, it would either have to shrink credit to the private sector or prepare for a much higher reserve money growth target.

“This would create a monetary overhang, and could spill over into inflation.”

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