RBI Panel Wants States To Build Larger Rainy Day Funds

Will It Help Or Hurt?

A CSF may help protect debt repayments in times of stress.

“The Committee underscores that CSF and GRF are reserve funds, constituted voluntarily by States for a specific purpose, and need to be built up substantially,” the report said. “Hence, the Committee urges the remaining States to join CSF/ GRF schemes, which would facilitate them to withdraw from the Fund to repay liabilities in times of need…”

The committee argued:

  • The CSF can act as a buffer fund for repayment of redemption dues.
  • Availability of a buffer fund increases the investors’ confidence in state borrowings and could bring down the cost of funds.

Historically, however, states have not seen many benefits to the fund.

The key concern for many states is they borrow from the market and set aside funds since most run a revenue deficit. As such, borrowing limits get utilised to put money away in this sinking fund. Also, these funds, until now, get locked in for a period of five years and states can’t withdraw the principal amount.

To counter these concerns, the committee suggests that the lock-in period of these funds be reduced to two years. States can also be allowed to the interest accrued for repayment of outstanding liabilities. In addition, states can continue to borrow against these funds at a rate 2% below the prevailing repo rate from the RBI’s ‘Special Drawing Facility’.

Not everyone sees merit in a larger reserve pool.

Govinda Rao, a member of the 14th Finance Commission, said there is merit in the idea of creating a buffer but the question is where that buffer is coming from. If a state is running a revenue deficit, it will be borrowing to put money in a reserve fund. That, according to Rao, counters common sense. “You borrow more to transfer funds to this reserve. What’s the purpose?”

Madan Sabnavis, the chief economist of CARE Ratings, also had some concerns. While the fund is a useful backstop, maintaining 5% of outstanding liabilities in it seems large, he said. It’s a losing proposition for states to borrow from the market and put money in the fund which earns a lower return, he said. Also, since borrowing limits for states are fixed, this will take away from funds they can raise for regular budget use.

Sabnavis said from the central bank’s perspective the idea is to introduce greater prudence in state finances and that is understandable. “But the reality is states have never been allowed to default and a larger fund may not be something that will put to use.”

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