Sinking fund

You will often hear that the central government or the state government or any company has incurred debt of so many crores.  Actually, this debt is incurred on the central government or the state government because they work to increase the welfare of all the people and not to earn profit.  After a few years, governments have to repay these loans with interest.

 What is a sinking fund?  (What is Sinking Fund): -

 A sinking fund is a kind of fund in which a fixed amount is deposited which can be used to repay the debt in future.  It is also called Debt Remittance Fund because the amount deposited in it is used to repay the debt in future and the government or company does not have to suffer much in repaying the loan.

 To make a sinking fund, according to its convenience, a certain amount is deposited every month, which after a few years becomes so much that it becomes useful to repay the debt.  Savings account in the bank is also synonymous with syncing fund account.

 The 12th Finance Commission (2005-10) recommended the creation of the Sinking Fund.  This fund is different from Consolidated Fund of State and Public Account.  This Finance Commission also said that the money deposited in it should be used only to repay the debt of the state government and not for any other purpose.

 Why is the sinking fund created? (What is the Objectives of a Sinking Fund): -

 If it is talked about in the context of a state government, it is made so that after the withdrawal of one government, the financial burden will be reduced on the future government.

 As governments keep changing in democracy, if the present government incurs too much debt on itself, then the responsibility of its payment will fall on the future government.  Therefore, every state government deposits 1% to 3% of its total debt in a consolidated sinking fund to repay the loan / bond payments that complete the maturity period in future and the government is not declared a defaulter.

 The Consolidated Sinking Fund in India was established by the Reserve Bank in 1999–2000 to enable states to repay their debt.  At present 23 states have set up consolidated sinking fund.  This fund of states is managed by the Reserve Bank.

 Sinking Fund Example

 Suppose the government of MADHYA PRADESH issued 200 crore bonds for a period of ten years (2020 to 2030).  This means that the government will have to pay 200 crore rupees to these bond holders in 2030 (interest is not taken into consideration for convenience).

 Therefore, the government collects 10 crore rupees in the sinking fund every year to deal with this responsibility.  This means that in 10 years, the government must have already deposited Rs 100 crore in this fund by 2030 to repay this debt, that is, it has to arrange only 100 crore rupees by not arranging the entire 200 crore in 2030.

 It is thus clear that with the help of this consolidated sinking fund, the state government has fulfilled its responsibility without any hassle.

 What is the facility provided to the State Governments through the Reserve Bank Sinking Fund? (Reserve Bank relaxation to states regarding Sinking Fund)

 Keep in mind that not all states have a sinking fund.  Only 23 states have deposited a total of Rs 1,30,431 crore as on 31 March 2020 in this fund.

 Now that states do not have the funds due to corona disease and they need some money to pay off their old debts in 2020 as well, the Reserve Bank has given the facility to states to pay 45% of their debt (13,300  Crores) can be withdrawn from this sinking fund.  This rebate facility will be available only till 31 March 2021.

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 The states that have accumulated the most money in this sinking fund will be the biggest beneficiaries of this relaxation.  See in the table above that out of the total of 1.30 lakh crore, Maharashtra has collected Rs 39,948 crore alone.  This means Maharashtra will get the most benefit of this rebate.