It has been almost 4 months into the COVID-19 Pandemic. Economies are failing, people are being let go of their jobs, and businesses are crashing. In a nutshell, it has been a nightmare for the corporate and the economic sector in almost every country on the globe. It is high time we start looking and understanding what the Indian Government is doing to revive the nation’s faltering economy. It becomes imperative, at this crossroad in our lives, to acknowledge the worsening situation and to gather as much information as we can, so that we prepare ourselves for good or for worse.
The general idea that the Indian government seemingly is going to follow is to meet the expenditure in the first half of the financial year by market borrowing and ensuring that re-prioritisation is done for various ministries. There is an obvious uncertainty about the length of this pandemic, and it seems that the finance ministry isn’t planning on rushing into any decisions early in the financial year. A lot of sources suggest that the government might even consider the possibility of using the Reserve Bank of India (RBI) to monetise the existing fiscal deficit in the second half of the financial year.
In simpler terms, RBI’s monetisation of the fiscal deficit in the Indian economy means that the bank will be printing currency for the government to cater towards any emergency expenditure during this crisis and lessen the fiscal deficit. The pandemic has had a terrifying impact on both direct and indirect revenues owing to the three-month nation-wide lockdown which was put in place to dampen the impact of coronavirus in the Indian population. This move forced the government’s hand to raise its full-year borrowing plan by almost 50% to meet its expenditure and financial commitments due to the coronavirus. Economists suggest that this could drastically increase the fiscal deficit to 5.5.% of the GDP from a previous 3.5%.
Mr N R Bhanumurthy, a professor at the National Institute of Public Finance and Policy suggests that the RBI could either print money or buy government bonds to reduce the deficit. He further says that if the government goes ahead with monetisation, they must specify that it is a temporary measure and should provide a road map for better understanding and to generate trust among the masses. Former Finance Minister, P Chidambaram and a lot of other economists have backed the idea of monetisation to aid the deficit.
On the other hand, former RBI Governor, Raghuram Rajan, at a conference organised by Singapore’s DBS Bank, on Thursday, said that the central banks in a lot of emerging markets are resorting to expanding its balance sheet and buying government debt owing to excess liquidity amid India’s economic slowdown. He also warned that monetising fiscal deficit comes at a cost and is not a permanent solution.
“The RBI has been expanding its balance sheet and it has been buying government debt. But effectively, in that process, what it is doing is borrowing from the banks at the reverse repo rate and lending on to the government.” Mr Rajan said.
At present, there is excess liquidity in the financial system of India as people are getting more cautious and are saving more. This is causing a decline in the demand for credit. The process of monetisation can be used for a very limited period only.
The former RBI Governor continued, “When does the process end? When people start fearing the extent of monetisation that is going, when they start worrying about inflation, and when they start worrying about whether debt that has been accumulated will be paid back or not.”
For now, there isn’t a lot of lending going on. Therefore, central banks can do monetisation. According to the famous economist, this will lead to cooperation between the central bank and the government. He continued to explain how once economies like that of India, fully open, all hell will break loose on the corporate sector. A lot of economic damages will be uncovered. Eventually, these damages and costs will be transferred to the financial sector. Mr Rajan said that the government must ensure that lenders are given appropriate financial incentives to tackle the crisis and not let this issue become something bigger than it should.
“We have managed to put economies into a coma, but when they awaken, it's going to be overly optimistic to assume everybody will walk off the sleeping bed and come back to full life," Mr. Rajan noted.
In the end, the ex-governor stated that many countries like India will experience a massive increase in debt to GDP ratio. He pushed for an open trade and investment climate suggesting that economic help must come from outside. The United States and China eventually will have to take on the lead and the comparatively smaller democracies will have to make do with trying to persuade the two big financial powers of the world to come together and avert a global economic crisis of even bigger ratios. Lastly, he mentioned the upcoming Presidential election in the United States of America and said that it could be a major influence in changing the course of things.
Although RBI participates in indirect monetisation through various open market operations, the repercussions of direct monetisation are much larger. It could hamper with the macro fundamentals of the country and risk a degradation by the credit rating agencies. This will have serious implications towards the country’s economy. Therefore, monetisation of India’s fiscal deficit is a very risky move for the Indian Economy to handle, given the current pandemic situation.
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