The fiscal deficit of both central and state governments is predicted to surge to around 15% of the Gross Domestic Product (GDP), a significant increase from the permissible limit of 6% as mandated by Fiscal Responsibility and Budget Management (FRBM) obligations. To mitigate the resulting financial pressure, the possibility of direct monetisation is being considered.
Fiscal Deficit Explained
A fiscal deficit refers to the total borrowings needed to reconcile the difference between government’s expenditure and revenues. These borrowings can either be obtained from internal sources such as the public, commercial banks, and the central bank, or from external sources like foreign governments and international organisations. For the government to secure these loans, the market needs to have available savings. However, current data indicates that the domestic household savings are dwindling and insufficient to support the government’s borrowing needs.
Foreign Investor Behaviour amid Economic Uncertainty
In these uncertain times, foreign investors are reluctant to provide loans and are instead moving their investments to ‘safer’ economies such as the USA. Economists suggest that developing economies like India should not have debt exceeding 80%-90% of the GDP. Currently, India’s debt stands at approximately 70% of its GDP. The government should adhere to a pre-determined amount of additional borrowing and ensure to reverse this action once the Covid-19 crisis subsides.
Direct Monetisation: Borrowing from the RBI
Direct monetisation involves the government requesting the Reserve Bank of India (RBI) to print new currency in exchange for new bonds. Although new currency notes increase the RBI’s liabilities, the acquisition of government bonds is an asset as they bear the government’s guarantee of repayment at a specified date. This method provides the government with cash to spend on alleviating economic stress through measures such as direct benefit transfers to the poor or infrastructure investments.
Direct Monetisation Strategies Worldwide During Covid-19
Amidst the Covid-19 pandemic, other countries have also explored direct monetisation. For instance, in April 2020, the Bank of England extended this facility to the UK government.
Potential Problems with Direct Monetisation of Government Deficit
While direct monetisation offers a short-term solution to boost overall demand when private demand is weak, it can also lead to high inflation. A slight increase in inflation can stimulate business activity, but excessive inflation coupled with high government debt can trigger macroeconomic instability. There are also concerns over inefficient and potentially corrupt spending choices by the government. Past instances of direct monetisation in India have led to serious economic consequences such as the balance of payments crisis in 1991 and a near-crisis situation in 2013.
In effect, even though direct monetisation may seem like an appealing solution in the short run, it is necessary to consider the potential problems and historical context associated with it before implementation.