MUMBAI: An increase in government borrowing runs the risk of flooding the debt market, and puts upward pressure on interest rates, making it more expensive for companies to borrow, said outgoing Reserve Bank of India Deputy Governor Viral Acharya.

In a lecture published on the Federal Bank website late on Monday, Acharya said India’s borrowing relative to its output has ranged from 67 per cent to 85pc since 2000 and has outpaced many emerging markets including China.

“As more government debt floods markets, the relative safety and liquidity premium attached by investors to high-rated corporate bonds diminishes, raising the cost of borrowing especially for AAA-rated borrowers and making it relatively less sensitive to policy rate cuts,” Acharya said.

The Reserve Bank of India (RBI) cut the repo rate to 5.75pc on June 6, its third cut in 2019, while also changing its policy stance to “accommodative,” after data showed the economy growing at its slowest in over four years.

Acharya is set to leave the central bank on Tuesday, six months before the scheduled end of his term in office. Acharya, who is a professor with the New York University’s Stern School of Business, cited personal reasons for the departure.

India should cut back on subsidies and programs that are not delivering long-term growth and divest more of its public sector holdings, Acharya said.

“The much-needed land, labour and agricultural reforms could be undertaken, all of which can help crowd-in private sector growth,” Acharya said.

There could be efficiency gains if there are more private investors playing an effective role in the governance of public sector enterprises, he added.

NBFC liquidity crunch

Acharya also noted that high, long-term government borrowing also impacts India’s non-banking finance companies (NBFCs), which are currently facing a severe liquidity crunch following the collapse of the Infra­structure Leasing and Financial Services (IL&FS) last year.

Regulators identified a surge in asset liability mismatches as one of the main drivers behind NBFCs’ liquidity woes.

NBFCs have been forced to raise short-term debt to fund long-term loans to home buyers or developers as there is relatively less appetite for longer-term debt in the Indian market.

“The ability and willingness of NBFCs to borrow long-term comes down when government borrowing increases; not only does their total debt come down in response, but they rely more and more on short-term paper,” Acharya said, adding that it risks making the financial sector more fragile.

Published in Dawn, July 24th, 2019