With the economy stalled, there isn’t enough money in the market for the government to borrow. Can it ask the RBI to print more money? How does this process work, and what are the arguments against it? Let us see:

Discuss the scope and feasiblity of “Direct” Monetization by the government for Deficit Financing as an option of the last resort.

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What is “direct” monetisation of the deficit?

• Imagine a scenario where the government deals with the RBI directly — bypassing the financial system — and asks it to print new currency in return for new bonds that the government gives to the RBI.
• Now, the government would have the cash to spend and alleviate the stress in the economy — via DBT to the poor or starting social and capital expenditure etc.
• In lieu of printing this cash, which is a liability for the RBI (recall that every currency note has the RBI Governor promising to pay the bearer the designated sum of rupees), it gets government bonds.
• Such bonds are an asset for the RBI since such bonds carry the government’s promise to pay back the designated sum at a specified date.
• And since the government is not expected to default, the RBI is sorted on its balance sheet even as the government can carry on rebooting the economy.

What triggers a demand for direct monetization?

1) Decline of Demand

• With a nationwide lockdown, incomes have fallen and so have consumption levels.
• In other words, the demand for consumer goods and services (say a haircut) in the economy has gone down.
• What can be done to boost demand? People need to have money. But, of course, who will give them money.
• From the highest-ranking CEOs to stranded workers, incomes have taken a huge hit, if not completely dried up.

2) Moving ahead for a fiscal deficit

• For its part, the RBI has been trying to boost the liquidity in the financial system. It has bought government bonds from the financial system and left it with money.
• Most banks, however, are unwilling to extend new loans as they are risk-averse. Moreover, this process could take time.
• The government’s finances were already overextended going into this crisis, with its fiscal deficit way over the permissible limit.
• On top of that, if the government was to provide some kind of a bailout or relief package, it would have to borrow a huge amount. The fiscal deficit will go through the roof.

3) No money in the market

• There isn’t enough money in the market for the government to borrow.
• Moreover, as the government borrows more from the market, it pushes up the interest rate.
• Hence, the govt. is left with the only solution — the “direct” monetisation of government deficit.

How is DM different form OMOs?

• Direct monetization is different from the “indirect” monetizing that RBI does when it conducts the so-called Open Market Operations (OMOs) and/ or purchases bonds in the secondary market.

Global examples

• Other countries are doing it to counter the economic crisis related to COVID-19.
• In the UK on April 9, the Bank of England extended direct monetisation facility to the UK government even though the Governor of the Bank opposed the move till the last moment.

Has India ever done this in the past?

• Yes, until 1997, the RBI “automatically” monetized the government’s deficit.
• In 1994, Manmohan Singh (former RBI Governor and then Finance Minister) and C Rangarajan, then RBI Governor, decided to end this facility by 1997.
• Now, though, even Rangarajan believes that India would have to resort to monetising the deficit.

Issues with Direct monetisation

• Direct monetisation of the deficit is a highly contested issue.
• Another former RBI Governor D Subbarao has said that there is no question that India must borrow and spend more in this crisis.
• He regarded this as a moral and a political imperative.

Issues: Inflationary practice

• Ideally, this tool provides an opportunity for the government to boost overall demand at the time when private demand has fallen — like it has today.
• But if governments do not exit soon enough, this tool also sows the seeds for another crisis. Here’s how:
• Government expenditure using this new money boosts incomes and raises private demand in the economy. Thus, it fuels inflation.
• A little increase in inflation is healthy as it encourages business activity. But if the government doesn’t stop in time, more and more money floods the market and creates high inflation.

To what level should government debt be ideally limited?

• While no ideal level of debt is set in stone, most economists believe developing economies like India should not have debt higher than 80%-90% of the GDP. At present, it is around 70% of GDP in India.
• It should commit to a pre-determined amount of additional borrowing and to reversing the action once the crisis is over.
• Only such explicitly affirmed fiscal restraint can retain market confidence in an emerging economy.
• The other argument against direct monetizing is that governments are considered inefficient and corrupt in their spending choices — for example, whom to bail out and to what extent.

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