Something is wrong. Money supply has expanded by 17.3 per cent during the 12 months ended June 5, 1998. This is fairly high. Year-on-year expansion of bank credit has absorbed but a half of the deposit accretion. There is considerable slack in the banking system. Banks, which are the principal buyers of government securities, should have eagerly lapped up government paper. But they have been coy.

In the current fiscal so far, the government has raised Rs 40,531 crore. Of this, `private placements' with the Reserve Bank added up to Rs 10,000 crore. Besides, the central bank has subscribed Rs 5,772 crore to the public offerings of Rs 30,531 crore. The total devolvement works out to Rs 15,772 crore. Close to two-fifths of thegovernment's market borrowings has come from the Reserve Bank of India.

The devolvement this year is three times as much as it was in the corresponding period a year ago. This by itself should not raise interest rates, since devolvements add to the money supply. It may be that the Reserve Bank is forcing the pace of government borrowings early this fiscal.

That is, it will sell the devolved securities later in the year to the market (principally, the commercial banks). Thus, the current money-supply expansion will be rolled back.

The strategy is not working smoothly. The first indication of this is the increase in yield rates on government securities offered for subscription towards the end of June. Even so, the Reserve Bank had to put in Rs 1,773 crore to complete the Rs 4,500-crore tranche. Rising interest and burgeoning devolvement are going hand in hand.

It seems the government is borrowing too much. Besides Rs 40,531 crore of market borrowings (a year ago, the borrowings were a third of thisamount), it has tapped from the Reserve Bank Rs 10,986 crore of ways and means advances (June 12). This is close to the permissible limit of Rs 11,000 crore for the first half of the fiscal. (Ways and means advances from the Reserve Bank were zero on June 13 last year.) These numbers point to profligate borrowing (spending).

Once ways and means advances cross 75 per cent of the permissible limit, the Reserve Bank is required to convert the excess into dated securities and sell these to the market. The question is, how many times will there be excesses in the current fiscal? Every excess will mean an offering to the market. (Note that the ways and means limit declines to Rs 9,000 crore in the second half of the fiscal and to zero on March 31, 1999. If the dawn shows how the day will be, the excesses will recur fairly frequently after October).

Thus, though the budget talks of net borrowings of Rs 48,326 crore, the government will demand far more from the market. The borrowing target was arrived at afterassuming additional revenue from imports, but the special additional customs duty has been halved to 4 per cent; it also assumed expenditure saving through a reduction in the fertiliser subsidy, but the Re 1 per kg increase in urea price has been withdrawn.

The demand for financial accommodation from the government (and the PSUs) is slated to be very large, beyond, it would seem, the accommodating capacity of the highly liquid market. The demand overload is bound to push up interest rates. This will raise the cost of the government's borrowings.Since the government is slated to overborrow (in relation to budget estimates), what is on the cards is the emergence of `crowding out'.

At rising interest rates, both public-sector units and corporates will slow down borrowings (since high-cost borrowings will not be commercially feasible beyond a point). This means that the investment slack in evidence for three years now will continue. There will be no let-up in the industrial recession.

The emerging scenariois a messy one. This is the reason why the authorities have failed to talk down interest rates. This is also why the market is asking for a cut in the cash-reserve ratio (CRR) of banks (beyond the Rs 2,568 crore of impounded money being released to the banks in 12 equal monthly instalments by March 13, 1999).

A CRR cut releases high-powered money, and boosts the money supply. To the extent the CRR is cut to offset the contractionary impact of a forex- reserve decline (misfortunes do not come singly), money-supply expansion will not accommodate the demand overload. If the cash-reserve ratio is cut too deep to expand money supply even more, that will perhaps enable the Reserve Bank to get rid of devolved securities. The consequent contraction of money supply may thwart the resurgence of inflation. But this will also give a fillip to interest rates - that is, force investment demand to make way for government borrowings. There is no escape from ``crowding out'' under a profligate government.