The Hindu Business Line : Economists not convinced with Govt’s clarification on OMOs

New Delhi, July 10 Monetary economists and some former RBI officials are unconvinced that Open Market Operations (OMOs), being contemplated by the Government and the RBI, will not amount to monetising the deficit.

“The key issue,” says a former RBI official “is what happens to net RBI credit to Government. If it increases, it causes the same effect as an increase in money supply. The rest is immaterial.”

Unsettled by the media and market response to the Finance Secretary’s statement that around half of the Government’s borrowing requirement of Rs 4.5 lakh crore would be financed by OMOs by the RBI, the Government had clarified on Thursday that OMOs do not mean monetisation.

It also clarified that it would not resort to the saving clause in Section 5 of the FRBM Act which permits the Government to borrow directly from the RBI — the equivalent of printing notes to provide a loan — in case of “extraordinary circumstances” such as “grounds of national security or national calamity or such other exceptional grounds as the Central Government may specify.”

It further clarified that the current economic situation would not be described as “such other exceptional grounds.”

The RBI is likely to opt for back-to-back transactions in which it buys bonds from the banks on the day before the Government securities auction and then, with the money they receive, the banks, on the next day, buy the Government securities. This is a technical solution to the problem caused by the ban in the FRBM Act.

But experts are not sure whether this was the intention of the legislation because, in effect, this stratagem results in the RBI lending directly to the Government. The letter of the FRBM is observed, but the spirit is breached.

Silver lining

The silver lining is that the bonds that the RBI buys and holds can be used for mopping up excess liquidity if the need arises. This need could arise after October if, as the RBI expects, there is a sudden and huge increase in capital inflows.

Much, though, depends on the monsoon. If it is highly deficient and growth dips below 6 per cent, the inflows may not materialise.

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