Finance Minister Pranab Mukerjee said at the RBI that the government investment programme will not be allowed to crowd out private investment.

Recent weeks have, however, seen a sharp increase in the government borrowing programme, and in yields on 10-year government bonds, on the one hand and in bank deposits going to finance purchase of government bonds (that is, the investment-deposit ratio) on the other. This is of concern, as during the year it is expected that demand for private credit will rise as investment picks up again. In an environment where credit to the private sector is perceived to be risky and government bonds safe, it will not be surprising if banks park more and more money with government bonds. The government needs to ensure that there is enough flow of credit to the private sector. If banks are unable to provide the necessary capital there has to be a focus on reform of financial markets such that this risk can be priced properly and does not become a reason to starve private investment of credit.

Further, as the budget indicated one-fourth of government spending today is on interest payments. The Central government is slated to raise more debt in the coming year than it has ever done in the past. The cost of this borrowing needs to be kept low. The bulk of government bonds are held by banks, the majority of which are public sector banks. Banks are statutorily required, through the Statutory Liquidity

Ratio, to hold one-fourth of their total assets in government bonds. So banks borrow from the public and redirect that money to the government. Regardless of how large the government debt is and whether the government has the ability to pay this debt or not, the Indian public is forced to (through the intermediation of banks) lend to the government. At the same time, the RBI, the government’s investment banker, also regulates banks. It can offload government bonds onto banks and overlook the interest rate risk when it comes to bank supervision. While explicit costs remain high, implicit costs through higher risk in the banking system are high. Also when banks are forced to lend cheaply to the government they recover their costs of deposits from the private sector. This shifts the burden to individuals borrowing from banks.

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