Views | The problem with government cash balances

Views | The problem with government cash balances

Prime Minister’s Economic Advisory Council (PMEAC) chairman C. Rangarajan recently said the government is likely to miss its fiscal deficit target of 4.6% of gross domestic product (GDP) for the current fiscal year. With not enough surplus cash left, borrowings remain the only option left to fund the widening deficit. Hence, the government has already announced its decision to borrow an extra 52,800 crore in the second half of 2011-12, putting strain on liquidity in the money market and possibly crowding out private borrowing.

Since cash is considered to be king, one might be tempted to believe that the more cash reserves as government has, the better its position; and the blame depleting cash reserves for the present economic malady. Not too long ago, the government had hoarded up a huge pile of cash with the Reserve Bank of India (RBI), following the windfall it earned from the 3G spectrum auction and strong advance tax collections. These cash reserves remained for a major part of the last fiscal year, as the government, for reasons best known to it, could not accelerate expenditure for the second half of 2010.

Contrary to expectation, these cash reserves which lay idle with the central bank proved to be a hindrance for an effective monetary policy and development of financial markets. It also reflected bad cash management.

With lack of coordination between RBI and the finance ministry regarding future requirement of cash and subsequent draw downs, the government’s cash flows more uncertain and thereby increases volatility of money market liquidity and short term interest rates.

The Deepak Mohanty committee, which was set up by RBI to study the operating procedure of monetary policy, has recommended an auction of excess government cash balances, to stop the uncertainty in liquidity conditions. The group also suggested that data on government cash balances be made public on a daily basis, to improve the assessments made by market participants.

Though these measures deal with usage of idle cash surpluses and minimizing its effect on markets, the group has not made any recommendation to discourage government hoarding of cash with RBI. Nor has it dealt with any measures for effective cash management to reduce volatility in cash flows of the government.

For instance the group might consider fixing a limit of cash surplus along the lines of ways and means advances (WMA) to reduce the volatility in cash flows. Further, to prevent a sudden pile-up of cash, advance taxes might be collected on a monthly basis instead of quarterly. Like in many Eurozone countries, RBI should also be allowed to invest government balances in the market and to use short-term borrowing instruments to manage the timing mismatch between inflows and outflows.