Monetisation Of Government Deficit May Be Inevitable Amid Coronavirus Disruption: C Rangarajan
Dr C Rangarajan, former governor of Reserve Bank of India. (Photographer: Namas Bhojani/Bloomberg News)

Monetisation Of Government Deficit May Be Inevitable Amid Coronavirus Disruption: C Rangarajan

It was in 1997 that India moved away from a regime where the central bank would buy government securities to provide for its expenditure. Known in technical parlance as the automatic monetisation of the deficit, the practice was seen as one that encouraged government profligacy and led to high inflation in the economy.

Starting April 1997-98, the RBI put a stop to that practice. The central bank governor who oversaw this defining transition in Indian monetary policy was C Rangarajan.

Now, 23 years later, India may be forced to move back into that era, at least temporarily, as the economy deals with the fallout of a rapidly spreading Covid-19.

The coronavirus, and lockdowns imposed to curb its spread, will lead to a surge in government expenditure. And monetisation of the additional borrowings needed to support this spending may be inevitable, Rangarajan told BloombergQuint in an interview.

“The fiscal deficit going up in itself means nothing except for the question⁠—who will subscribe to the additional borrowings? In this case, what will happen is that the RBI will have to come in and support it either through the primary market or the secondary market,” Rangarajan said.

Monetisation of the deficit is inevitable. Such a large increase in expenditure cannot be managed without monetisation of government debt.
C Rangarajan, Former RBI Governor

That’s not to say the central bank should throw all caution to the wind.

Rangarajan cautions that a huge increase in the fiscal deficit could lead to a spike in inflation.

The fiscal deficit may need to widen to nearly double the mandated target of 3 percent set under the Fiscal Responsibility and Budget Management Act. This, together with the deficit of states, could mean a general government deficit that is close to 10 percent of the GDP, he said.

“I agree that at a time like this we can’t be counting the fiscal deficit but, at the same time, we must be aware that a huge increase in fiscal deficit, at a later point in time, could lead to an inflationary situation unless production rises very sharply,” he said.

The RBI and all authorities must bear in mind the consequences of excessive monetisation of debt, Rangarajan added.

Spending & Planning Priorities

The former RBI governor sees two immediate spending priorities for the government ⁠— the expenditure needed to strengthen the country’s healthcare infrastructure and the money needed to support those whose livelihoods have been impacted.

The third kind of expenditure will be that is needed to provide stimulus to the economy and organised sectors, such as aviation and hospitality, hurt by the spreading virus.

“The first two expenditures need to be tackled immediately. The government should spend massively in order to address those expenditures. Later on, we can think about providing stimulus to the economy.”

At the same time, significant planning will be needed to manage supplies and supply chains. The spread of the pandemic has meant lockdowns in many large countries and that means that the production system comes to a near halt, said Rangarajan. This will create supply bottlenecks globally.

Similarly, supply bottlenecks are being created within the country as states restrict the movement of goods across borders. The absence of material inputs globally and domestically can clearly make it difficult for the production system to move, he said.

Some sort of greater leadership at the global level is required to ensure we move towards a more balanced approach, where goods start moving. But, when all is said and done, we are paying the price of globalisation, which has made the world more integrated, which works well in good times but causes problem in times of distress.
C Rangarajan, Former RBI Governor

Role Of Central Bank

Amid the many disruptions faced by the economy, what is the role of monetary policy and the central bank?

According to Rangarajan, the most important role of the central bank at a time like this is to see what it can do to support the programmes of the government.

The second task for the central bank is to take steps to stimulate the economy. “Here, I have one point to make, which is important. The mere provision of liquidity and the lowering of interest rates will not help until the productive system begins to operate,” Rangarajan said.

India’s monetary policy committee cut rates by a steep 75 basis points last week. In addition, the RBI said it would add nearly Rs 3.7 lakh crore in liquidity via a variety of tools. This may not help immediately, Rangarajan cautioned.

The experience the world over has been that the mere reduction of interest rates and the mere provision of liquidity, by itself, will not bring about a change. The whole perception in the economy has to change and there must be a belief that the economy must move forward and that’s where the government comes in. An overall environment will have to be created to get the economy’s productive capacity going.
C Rangarajan, Former RBI Governor

The RBI also allowed banks to offer a three-month moratorium to all term loan and working capital borrowers. These measures, called regulatory forbearance, are intended to ensure that banking system rules don’t come in the way of recovery efforts at a time like this, Rangarajan said.

The central bank must give in to some regulatory forbearance for a time so that banks can continue to lend, said Rangarajan, adding that the system can be tightened once the crisis passes.

Should more direct support be needed, in the form of offering guarantees to lenders for lending to certain segments, the government should consider doing this rather than the central bank.

“The real support (from the central bank) will have to be to the government in order to undertake those expenditures,” Rangarajan said.

Watch the full conversation below:

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