Last year saw a big increase in the Government's deficit as the Covid pandemic depressed revenues. And to fund this higher deficit, the Government had to borrow a lot more from the market. Aggregate market borrowings (net of redemptions) of Central and State Governments (dated securities and treasury bills) doubled in FY21 to ₹20tn from ₹10tn in FY20. Most of the increase was due to higher borrowings by the Central Government.
The general expectation was that this increase in borrowing would have to be absorbed by the RBI stepping up its purchases of Government securities. But it turns out that RBI was not the largest purchaser of Government securities – either in absolute or relative terms.
The increase in RBI’s holdings of Government securities in FY21 amounts to just 15% of net market borrowings (Centre + States). Two years ago, in FY19, the RBI had absorbed a far higher proportion of Government borrowings. What this means is that there was not a lot of ‘deficit monetisation’ in FY21. So, who absorbed this huge increase in Government borrowings?
Banks & other financial institutions, as well as Insurance companies are the traditional buyers of a large amount of Government securities (partly due to regulatory reasons). And not surprisingly, they were large buyers of Government securities in FY21 as well. These two bought 50% of the Government borrowings last year.
But most surprisingly, it was the Mutual Funds that have emerged as a key buyer of Government securities in recent quarters. Mutual Funds more than doubled their holdings of Government securities in FY21. In the last two years, Mutual Funds’ have purchased more government securities than either the RBI or Provident Funds (excl. Pension Funds). Mutual Funds now hold almost 3.5% of outstanding Government securities as of March-2021, up from less than 1% just two years back.
There is a small technicality though. The RBI currently holds more government securities than mentioned above. This is because it has infused liquidity through Repo transactions. In a Repo transaction, the RBI provides money to Banks and in return Banks give Government securities to the RBI. But the RBI is not the owner of these securities but rather these securities are mortgaged with it. When Banks return the money to the RBI at the end of the term, the RBI must return the securities back to the Banks. And hence Repo transactions are accounted for as a ‘collateralised borrowing/lending’ and not outright sale/purchase. These securities are thus excluded from RBI’s ownership.