From UPSC perspective, the following things are important :
Prelims level : Perpetual bonds.
Mains level : Paper 3- What are the option available with the government to raise the money to fight the covid pandemic?
The government is exploring ways to raise money to deal with the destruction caused by COVID pandemic. One of the suggestion is the monetisation of fiscal deficit. But this article looks into an alternative approach of issuing bonds based on the idea of Consol bond issued by the British government during WW 2. So, how much amount needs to be raised? and why a perpetual bond like Consol bond is a suitable option for India? Read to know!
A gathering financial storm
- India projected a deficit of ₹7.96-lakh crore in the Budget before the pandemic.
- Adding to the above concern: 1) Off-balance sheet borrowings of 1% of GDP. 2) The overly excessive target of ₹2.1 lakh crore through disinvestments.
- Thus, financial deficit number is set to grow by a wide margin owing to corona crisis.
- There will be revenue shrinkage from the coming depression that will most certainly be accompanied by a lack of appetite for disinvestment.
Need for stimulus package and measures taken by the RBI
- In addition to the expenditure that was planned, the government has to spend anywhere between ₹5-lakh crore and ₹6-lakh crore as a stimulus package.
- The stimulus provided by the government so far and recent announcements by the Reserve Bank of India (RBI) achieved little.
- All the RBI’s schemes are contingent on the availability of risk capital, the market for which has completely collapsed.
- The government and the RBI have tried several times to increase lending to below investment grade micro, small and medium enterprises, but have come up short each time.
- Furthermore, while the 60% increase in ways and means limits for States is a welcome move, many States have already asked for doubling the limits due to the shortages in indirect taxation collections from Goods and Services Tax, fuel and liquor.
- The government and the central bank need to understand that half measures will do more harm than good.
What is the Consol Bond?
- Consol bond is a form of British government bond that has no maturity and that pays a fixed coupon.
- Consols are basically rare examples of actual perpetual bonds.
- The bonds were issued in 1917 as the government sought to raise more money to finance the ongoing cost of the First World War.
So, why bond like Consol Bonds is a good option for India?
- There is no denying the fact that the traditional option of monetising the deficit by having the central bank buy government bonds is one worth pursuing.
- Citizens’ active participation is ensured in Consol Bond type alternative.
- Furthermore, with the fall of real estate and given the lack of safe havens outside of gold, the bond would offer a dual benefit as a risk-free investment for retail investors.
- When instrumented, it would be issued by the central government on a perpetual basis with a right to call it back when it seems fit.
- An attractive coupon rate for the bond or tax rebates could also be an incentive for investors.
- The government can consider a phased redemption of these bonds after the economy is put back on a path of high growth.
The solution of bond offered here could be a valuable addition in points to the answer to the question which asks about the ways to raise money. Consider the question, “Economic devastation caused by the COVID pandemic has forced the government to explore the various ways to raise the money. Discuss the options available with the government and issues associated with the options.”
Politicians and epidemiologists across the world have used the word “war” to describe the situation the world is currently in. So, to raise the money to fight this war against Covid-19, we can take the cue from past and issue bond based on the Consol bond.
Back2Basics: What is fiscal deficit?
- A fiscal deficit is a shortfall in a government’s income compared with its spending.
- The government that has a fiscal deficit is spending beyond its means.
- A fiscal deficit is calculated as a percentage of gross domestic product (GDP).
- There can be different types of deficit in a budget depending upon the types of receipts and expenditure we take into consideration. Accordingly, there are three concepts of the deficit, namely-
- Revenue deficit = Total revenue expenditure – Total revenue receipts.
- Fiscal deficit = Total expenditure – Total receipts excluding borrowings.
- Primary deficit = Fiscal deficit-Interest payments.
- Primary deficit shows how much government borrowing is going to meet expenses other than interest payments.
- Thus, zero primary deficits mean that the government has to resort to borrowing only to make interest payments.
- To know the amount of borrowing on account of current expenditure over revenue, we need to calculate the primary deficit.
- Thus, the primary deficit is equal to fiscal deficit less interest payments.
- A perpetual bond, also known as a “consol bond” or “prep,” is fixed income security with no maturity date.
- This type of bond is often considered a type of equity, rather than debt. One major drawback to these types of bonds is that they are not redeemable.
- However, the major benefit of them is that they pay a steady stream of interest payments forever.
- Perpetual bonds exist within a small niche of the bond market.
- This is mainly due to the fact that there are very few entities that are safe enough for investors to invest in a bond where the principal will never be repaid.
- AT-1 bonds which were recently in news due to YES bank failure is an example of a perpetual bond.