The Central Bank of India i.e. RBI acts as a banker to the banks as well to the central and state governments. As we have our bank accounts with the commercial banks, the banks and government have their current accounts with the RBI. The central government, as well as the state governments, receives revenue by levying some direct as well as indirect taxes. The government spends this money on development activities, welfare schemes, to pay various debts it has taken previously and so on. But when the expenditure of the government exceeds as compared to revenue, then what? In this scenario, the Reserve Bank of India provides a short-term loan to the central and state governments to fill this gap. This temporary loan facility is called Ways and Means Advances.
This means to fill out the temporary gap of receipts and payments of the government, section 17 (5) of the RBI Act 1934 empowers RBI to grant Ways and Means Advances to the central and state governments. The Ways and Means Advances is a collateral free loan provided by the RBI to the government. The Ways and Means Advances scheme was introduced on April 1, 1997. Before the introduction of Ways and Means Advances Treasury Bills were used to meet the short-term needs of the government.
Classification of Ways and Means Advances
WMA to the Central Government
The limit and time period for the Ways and Means Advances is decided by the central government in consultation with the Reserve Bank of India. If the central government borrows more than the limit decided, then it is considered Overdraft. The interest rate for Ways and Means Advance is equal to Repo Rate for the initial 90 days and Repo Rate + 1 % after that. While the interest rate for Overdraft is Repo Rate + 2 %. As per the provisions in March 1997, between the Central government and the RBI, the overdraft beyond 10 consecutive working days (this limit is for overdraft not for WMA) will not be allowed.
WMA to the State Governments
The limit for Ways and Means Advances to the State Governments varies from state to state depending upon their economic health. This limit was last revised on 29th January 2016 based on the recommendations of Advisory Committee on WMA headed by Shri Sumit Bose.
In addition to the Ways and Means Advances, the state governments are also eligible for Special Drawing Facility. But in the case of Special Drawing Facility, the advances are provided against the government securities held by the state governments. It means borrowing under Special Drawing Facility is not collateral free like Ways and Means Advances. The state governments can avail advances from RBI under WMA only when the limit for Special Drawing Facility is exhausted.
When the state governments exhaust both the limits i.e. WMA limit and Special Drawing Facility limit, then Overdraft comes to rescue. Overdraft facility is provided to state governments for a maximum of 14 consecutive working days.