“It's a qawwali kind of day?” she asked, as soon as she entered my room overlooking the bus depot.

“I find the rhythm of a qawwali like the rhythm of life,” I said.

“Oh,” she said. “I was reading the Minutes of the Monetary Policy Committee Meeting of the Reserve Bank of India (RBI), held earlier this month and I came across something, which I need you to explain.”

“Sure.”

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“Viral Acharya, who is one of the deputy governors, said: “Estimates of overall public sector borrowing requirement (PSBR) have now reached between 8% and 9% of GDP. Further, PSBR impairs monetary policy transmission due to crowding out effects on market financing through public bonds and on bank deposits.”

“Okay.”

“Can you please explain this to me in simple English?”

“This is how it is. The central government spends a certain amount of money every year. The problem is that it does not earn all the money it spends. The difference between what a government earns and what it spends is referred to as fiscal deficit. The government finances this fiscal deficit through borrowing. Other than the central government, there are state governments as well. Almost all the state governments run a fiscal deficit and they also finance it through borrowing.”

“Hmmm.”

“And now comes the tricky part. Government borrowings go beyond financing the fiscal deficit.”

“How?”

“The government accounting works on a cash basis. Unless money actually leaves a government account, it is not counted as an expenditure. In normal accounting, if an expenditure is due it is counted as expenditure, irrespective of whether it has been paid for or not.”

“And how does this matter?”

“Every year to show that the fiscal deficit is under control, the central government does not pay expenditure that is actually due.”

“As in?” she asked.

“Take the case of the Food Corporation of India (FCI). FCI buys rice and wheat directly from farmers and then sells it through the public distribution system shops at a much lower price to meet the requirements of the Food Security Act. It needs to be compensated for these under-recoveries.”

“Hmmm.”

“The government pays for these under-recoveries through the food subsidy allocated in the budget.”

“Okay.”

“The food subsidy allocated in the budget is never enough to pay for the under-recoveries of the FCI. The government accounts work on a cash basis. Hence, even though the payment is due to FCI, the fact that it is not made, means, that it does not get counted as expenditure.”

“Oh.”

“By allocating less food subsidy than it should, the government is able to control its expenditure and in the process show a lower fiscal deficit.”

“Hmmm.”

“The problem is it doesn't mean anything. Given that, FCI does not get compensated adequately it has to borrow to keep its operations going. The financial system lends to FCI knowing fully well that it is backed by the government. While the lending ends up in the books of the FCI, it is actually lending to the government.”

“Makes sense.”

“Once we take the borrowing to finance the central government fiscal deficit, the fiscal deficits of the state governments and other FCI kinds of borrowings into account, what we get is what economists call the public sector borrowing requirement.”

“And that is quite a lot?”

“Yes. While the declared central government fiscal deficit in 2018-2019 was 3.4% of the Gross Domestic Product (GDP), the actual public sector borrowing requirement was around 8.5% of the GDP.”

“What impact does it have on the common man?”

“With the government and its arms borrowing as much as they are, this crowds out other borrowers, leaving a lesser amount of money for them to borrow. This includes those companies and institutions wanting to issue bonds to raise money. It also crowds out banks looking to raise deposits to give out as loans. Hence, they need to offer a higher interest in order to raise deposits. And when they offer higher interest on deposits, they need to charge higher interest on their loans.”

“Which is why interest rates on loans haven't fallen despite the RBI through its monetary policy cutting interest rates thrice this year.”

“Yes, it is one of the major reasons. This is why your home loan EMI hasn't come down.”

“Now, I understand.”

The example is hypothetical.

Vivek Kaul is the author of the Easy Money trilogy.