All major economies in the world have unleashed massive fiscal stimulus packages to tackle the economic fall-out of the coronavirus outbreak.
In contrast, India’s fiscal stimulus package has been minuscule. In March, the Government had announced Rs.1.2 trillion stimulus package targetted towards the poor, low-income and vulnerable segments of the population. This allocation amounted to just 0.8 % of India’s GDP.
India has limited fiscal space to meet the expenditure requirements under these extraordinary circumstances. If the Government intends to provide a bigger package, it will have to borrow a huge amount (from the market by issuing bonds). But, this option has limits because of the low level of national savings. Also, it would increase the cost of borrowings in the economy and drive out private investment.
Therefore, several economists have called out for debt monetisation. In this post, I attempt to answer a few questions regarding the same.
What is debt monetisation?
It is a euphemism for ‘printing of money’ by the RBI. It is also called ‘helicopter money’.
Debt monetization is basically financing of fiscal deficit by the Central Bank. The Central Bank purchases Government bonds directly from the Government.
[You may read: Fiscal deficit; primary deficit; revenue deficit explained]
Let’s say- the Government has a fiscal deficit of Rs.100000. It can issue bonds worth Rs.1000000, which the Central bank purchases and holds indefinitely. It has the same effect as printing of new money, as this doesn’t have to be repaid and doesn’t impose any debt burden on the Government.
The Central Bank purchasing the equivalent amount of bonds from the market through Open Market Operations (not directly from the Government) also has the same effect. It is precisely what is done by the Bank of Japan. It buys roughly the same or bigger amount of bonds issued by the Government. Though the bank of Japan refutes the allegation, it is a type of debt monetization.
Is it allowed in India?
Until 1997, India’s deficits were automatically monetised. This was done by the automatic issuance of ad-hoc treasury bills to the RBI in case of a fiscal deficit.
[Read: What is treasury bills?]
The Central Government had to maintain a minimum balance with the RBI. If the balance fell below the required limit, ad hoc treasury bills would automatically get issued to the RBI on behalf of the Government. These bills were of 91-day maturity.
An agreement was signed in 1994 to phase out the system of ad-hoc treasury bills by the year 1997 to strengthen fiscal discipline. In the year 1997, Ways and Means Advances (WMA) was introduced.
(Read: What is WMA?]
But, why are people calling for debt monetisation now?
Extraordinary times require extraordinary measures. Higher fiscal deficit is inevitable to combat the corona induced slowdown. As per an estimate by Subhash Chandra, in light of the current pandemic, the government may have to resort to additional fiscal deficit financing of Rs. 10-11 lakh crore. (taking into account revenue shortfalls due to economic disruptions). This is unprecedented.
Borrowing from the market will result in an increase in the cost of borrowings which crowds out private investment.
So, is monetisation the same as Quantitative easing?
Quantitative easing (QE) also involves purchasing of Government bonds from the Government or commercial banks. But, the central bank doesn’t intend to hold the bonds indefinitely. It is not a permanent source of financing.
[You may read: Quantitative Easing Explained]
Bond purchases under QE are temporary. But, recent QE programs are likely to be permanent. The Central Banks (in the US, Europe) haven’t been able to sell the bonds they had accumulated under QE. Though it’s intended to be reversible, it’s not always the case. So it’s difficult to distinguish between QE and monetization.
Are other countries resorting to debt monetisation to tackle corona induced crisis?
Yes. On April 9, the UK became the first major economy to announce deficit financing.
Should India do it?
Given, the limited fiscal space and massive expenditure requirements, India can consider it as an option.
As the then RBI Governor, C Rangarajan decided to phase out the direct monetization of debt by 1997. Given the circumstances, even he feels India should resort to it.
If deficit financing is done without limits, it can trigger hyperinflation, but the crisis is deflationary in nature. Also, in the developed economies, the quantitative easing of the past decade has not lifted inflation above 2 %.
In a recent Linkedin post, Raghuram Rajan said that monetisation will neither be a game-changer in stressed times nor a catastrophe, if done in a measured way. The Government should be concerned about protecting the health of the economy and should spend what is needed. Obviously, it should try to cut back ‘unneeded spending’, and prioritise.
To conclude, ‘printing of money’ to mobilise resources should be available to the policymakers as an option, but it should be taken only as a temporary measure necessitated by the scale of the pandemic. The RBI should impose limits on the Government. And the Government also should lay down a clear roadmap to get its debt back in shape so as not to spook the global investors and credit-rating agencies.
[You may also read- Modi’s 20 lakh crore economic package- Is it worth all the hype?]
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