How Long Can RBI Monetise Government Debt? Raghuram Rajan Weighs In

The central banks of many emerging markets, including India’s, are expanding their balance sheets in response to the Covid-19 outbreak. While proponents of modern monetary theory say the exercise needn’t be limited, Raghuram Rajan countered it.

While central banks can expand their balance sheets for a while, it’s really the consolidated balance sheet of the central bank and the governments you’re looking at, and there’s a limit to that, the former Reserve Bank of India governor said in his keynote address at the DBS Asian Insights Conference on Thursday.

Rajan said RBI has been expanding its balance sheet and buying government debt. Effectively, it’s borrowing from banks at the reverse repo rate and lending to the government. That’s something it can do as long as banks are willing to be passive co-operators in this process, he said.

That can stop in multiple ways, according to him. “When people start fearing the extent of the monetisation that’s going on, when they start worrying about inflation and debt that has been accumulated or when growth starts picking up and banks find other uses for their money than passively holding on to central bank reserves,” he said.

For now, when there’s not much lending going on, this is something that central banks can do, he said, adding this leads to cooperation between the central bank and the government.

For industrial countries, central banks can do this in a much bigger way but there are limits to that also, he said. With a few more quarters of spending that’s amounting to as much as 15 percentage points of gross domestic product in case of some of these economies, we will reach that limit, he said.

A Matter Of Survival

The former RBI governor said in countries like India and Brazil, there has been very modest support to people and to companies. Therefore, when the economy opens up more, more damage will be uncovered.

“We have put economies into a temporary coma and when they awaken, it will be overly optimistic to assume that everyone will walk off from the sleeping bed and come back to full life,” he said.

Governments will have to think about costs the financial sector will have to bear and capitalise it adequately.

On the impact of coronavirus in emerging economies, where it has still not been contained, Rajan said the longer the virus lasts, the greater will be the damage to economies. Helping an economy that’s locked down to survive is extremely costly, he said, adding that countries lose one-twelfth of their GDP for every month that they’re in complete lockdown. Unlike in richer countries, a lot of people can’t work in these economies amid restrictions to contain the virus.

When asked how have governments across the world have performed, Rajan said one must examine two factors. One, how you have dealt with the virus and another, how you manage recovery, he said. “The most important difference among economies is who has been able to spend.”

Also Read: Deficit Monetisation Not On Table At The Moment: Economic Affairs Secretary

Citing the IMF’s last report, Rajan said it suggests that in industrial countries, combined fiscal measures with credit measures amount to about 20 percentage points of the GDP. If you look at emerging markets, it comes to about 5 percentage points on average. If you look at the poorest countries in the world, it’s barely about a percent. “It’s the same virus but they have different capabilities of spending money on it.”