Funding India’s Economic Recovery The Prudent Way

RBI’s own actions may be contributing to the plausible equity bubble that it warns us of, writes Ananth Narayan.

<div class="paragraphs"><p>Vehicles travel along the Agra-Lucknow Expressway, in Uttar Pradesh. (Photographer: Prashanth Vishwanathan/Bloomberg)</p></div>
Vehicles travel along the Agra-Lucknow Expressway, in Uttar Pradesh. (Photographer: Prashanth Vishwanathan/Bloomberg)

Ten days ago, the Reserve Bank of India declared that it would transfer a surplus of Rs 99,122 crore to the Government of India, around twice the amount budgeted.

As we battle the pandemic, this feels like welcome news. Is there more where this money came from?

Committees have agonised over how much surplus the RBI should transfer to the government. Let’s avoid that end of the debate.

Instead, let’s evaluate the outcomes of such transfers on the economy.

We argue that RBI surpluses spent by the government amount to money creation, funded by forced, cheap, short-term banking loans to the sovereign. These reduce real interest rates and penalise savers. In the current context, this entails the risk of asset price and general inflation, widening inequities, and external imbalances – without any obvious benefits to private investment.

We argue that there are better ways of funding much-needed government spending now, by recycling existing money, and without taking on as many attendant risks.

RBI Surplus Transfers – The Impact

What happens when the Government of India transfers Rs 1 lakh crore of RBI surplus to banks, for onward credit to the banking accounts of various beneficiaries?

In accounting-speak, banking system assets will increase by Rs 1 lakh crore, by way of higher balances in their accounts with RBI (the banker to banks and government). This reflects the transfer from the government for onward credit to beneficiaries.

In turn, banking system liabilities will also go up by Rs 1 lakh crore, as beneficiary accounts in the banking system are credited with these funds. With this, additional ‘money’ will be created in the form of customer deposit balances.

Banking Balances With RBI

Let us take a closer look at the additional Rs 1 lakh crore that the banking system now has with the RBI.

These funds must be placed with the RBI (itself a part of the sovereign), on terms set by the RBI. For now, the RBI might borrow these funds overnight from the banking system at the Liquidity Adjustment Facility reverse repo rate of 3.35%.

The banking system by itself cannot deploy these funds into long-term, better-yielding assets. When banks lend money to each other or their clients, they merely pass these funds amongst themselves, without impacting the overall quantum.

Banking funds with the RBI only net-reduce when the RBI chooses to sell or lend banks assets (like bonds or foreign currency), change statutory ratios, or when there is a withdrawal of currency notes by depositors. None of these are in the hands of banks.

In summary, when the Government of India spends RBI surpluses, the sovereign is in effect borrowing cheap, short-term money from the banking system, on its terms, to fund its spending. In turn, the banking system would pass on lower term interest rates to its depositors.

This contrasts with the more conventional market-linked, long-term borrowing by the issuance of government bonds to fund fiscal deficits.

Taxing Savers

Besides RBI surplus transfers, sovereign spending backed by the RBI’s bond purchases under its Government Securities Acquisition Programme or GSAP and open market operations have a similar effect of providing the sovereign with short-term bank funding, while pushing down interest rates.

Weighted average bank deposit rates have fallen to an all-time low of 5.4%, even as 3-month inflation expectations are at 10.4%.

There can be little argument around the need for the government to spend through the pandemic. But this manner of funding government spending taxes our vast community of small savers, including retired folk, with long-term savings rates forced far below perceived inflation. Some savers are then pushed to consider riskier assets such as equities and gold.

RBI’s own actions may be contributing to the plausible equity bubble that it warns us of, in stark contrast to the distress in the broader economy.

There are real risks to financial stability – of asset and general inflation, widening inequities, and eventual external imbalances – that stem from consistently large, negative real rates of return to savers. Against this, there is little evidence of easy money now revving up private investments.


There are alternative ways to fund much-needed government spending, with fewer attendant risks.

One theme would be to recycle the existing money supply, rather than add to it. Given all that we described, readily deployable money — currency in circulation, and current and savings accounts with banks — has grown by 15.0% annually over the past two years. This is despite the economy itself shrinking through this period. There is plenty of near-cash savings that are available to fund the government.

Asset disinvestments by the government could extract some of this existing money from savers.

Additionally, the government could offer savers a one-time attractive fixed income return (say 6.0% tax-free for 5 years), on a special ‘Atmanirbhar bond’. Such a scheme could raise Rs 3-4 lakh crore of existing money within a short time.

When Government of India spends such funds, money supply would be restored, recycled from savers looking for fair yields and returns, to those who could use the funds for relief and recovery. Giving savers a legitimate deployment avenue would reduce the risks to financial stability described earlier.


Government spending of RBI surpluses amounts to money creation and repression of interest rates. As with RBI bond purchases, it puts lipstick on the pig of deficit monetisation, and severely taxes savers. Currently, there is little evidence of all this money supporting growth. Instead, large negative real rates heighten risks of asset price and general inflation, widening inequities, and eventual external imbalances.

Rather than combing sovereign books for more surpluses or indefinitely expanding RBI bond purchases, we might be better advised to try and recycle money supply by offering a legitimate return to our savers. To that extent, divestment of government assets, and a special one-time Atmanirbhar bond that offers attractive post-tax returns to savers, may be a more durable way of funding much-needed government spending.

Ananth Narayan is Associate Professor - Finance at SPJIMR. He was previously Standard Chartered Bank’s Regional Head of Financial Markets for ASEAN and South Asia.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.