18 Aug 2021 gs-mains-paper-3 INDIAN ECONOMY
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A-CUBE IAS Answer :
What are Oil and Recapitalisation Bonds? What are their impacts on the fiscal health of the Indian Economy. How will it effect the investments in the Economy?
(GS MAINS PAPER - 3)
Recapitalisation Bonds is a government bond that is an instrument that can be termed as a new capital to improve the balance sheet of the public sector companies that are undergoing credit crunch.
Recapitalisation bonds is a broader term that could be for oil, food, fertilizers, PSU Banks etc. With these Bonds government raise money from the market with a promise to repay the face value of the maturity date and a periodic interest.
In recent days, rise in petroleum prices and share of government taxes has come in picture as government has defended the higher excise as some of the oil-bonds are maturing in recent month and following years.
Be it oil subsidy when India had Administered Price Mechanism (APM) system in place in oil sector or food/fertilizer subsidy or the much talked about accumulation of non-performing assets (NPAs) for financial companies, particularly Public Sector Banks, instead of taking refinancing risks that would have had a major bearing on fiscal deficit the government retorted to issuing Recapitalization Bonds.
What is the need?
Government being the biggest shareholder in public sector oil marketing companies, public sector banks, food and fertilizer companies fulfils the responsibility of infusing capital by using different instruments.
By issuing long dated special securities as compensation in lieu of cash subsidies that could impact government’s overall debt/GDP ratio, Recapitalization Bond is one such instrument that is a preferred option to mitigate credit rating risks in short-term, these longer dated recapitalization bonds, staggered over 10-15 years’ maturity makes refinancing risks lower.
Though, these securities may carry a marginally higher coupon over the yield of the dated securities of comparable maturity, but this is an attractive route that it does not add to the fiscal deficit, but the government is liable to pay the interest and face value of the bonds on maturity.
Recapitalisation Bonds – The Method
To ease out the credit crunch, government issues recapitalization bonds that such companies subscribe as in investment. The money realized by the government through these bond sales, goes back to these companies as capital thus strengthening their balance-sheets. The money raised by the government for subscribing recap bonds from banks and financial institutions is free from becoming a bad loan as it comes with sovereign guarantee.
Impact on the fiscal health of Indian Economy
Being cash neutral transection, such bonds have limited immediate impact on fiscal deficit; fiscal deficit is impacted only by the interest cost on the bonds that the government pays every year. On the other hand, this shore up their capital reserves and enhance credit flow into the economy.
Since it is a long-term debt, it provides time to banks, oil-marketing companies, fertilizer companies to improve their balance-sheets by increasing their credit and private investment. The positive aspect is as the financial stability returns, the government, then, can retire the debt from the proceeds by selling the equities purchased earlier, once companies’ situation gets better.
How will it affect the investments in the Economy?
The banking sector is an industry and a section of the economy devoted to the holding of financial assets for others and investing those financial assets as a leveraged way to create more wealth.
This process in the economy brings about a chain effect as a strong financial infrastructure is a catalytic agent that affects the growth. With country’s stable fiscal and robust growth, the liquidity in the system fuels private sector capital expenditure and contribute in financial stability and sustain economic growth.