Covid-19 Response: Can Modern Monetary Theory Come To India’s Rescue?
A five hundred rupee note is arranged for a photograph in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)

Covid-19 Response: Can Modern Monetary Theory Come To India’s Rescue?


As Covid-19 pushes the world economy into recession, key developed markets are throwing additional fiscal spending between 5 percent and 20 percent of their gross domestic product at the problem.

India’s policymakers, however, are in a bind. Even before the impact of Covid-19 hit us, we started with a much weaker economy and fiscal balance than we cared to admit. We must spend more now, just to stave off a humanitarian and economic crisis. But should our rallying cry be to “do whatever it takes”, or a more constrained “do whatever minimum we can survive with”?

One heterodox economic policy framework that could justify a higher fiscal spend is Modern Monetary Theory or MMT, advocated by the likes of Randall Wray. Critics of MMT such as Thomas Palley warn that MMT will sound especially attractive in desperate times – such as today – when we are clutching at straws. Nevertheless, let us consider the MMT prescription for India, and weigh it against more mainstream remedies.

The MMT Heresy

Wray describes the MMT framework as follows.

MMT would apply to any economy that imposes obligations (like taxes) and issues obligations (like government debt) largely in its own sovereign currency.

MMT postulates that such an economy does not face a budgetary financing constraint the way a household does, because it “cannot run out of money”.

MMT’s key policy goal is full employment. As long as there is unemployment, MMT calls for government spending on job creation, without worrying about persistent fiscal deficits. At full employment, MMT prescribes taxes and government borrowing to counter inflation.

In MMT, therefore, taxes and government borrowing are instruments to contain inflation, rather than to fund government spending.

Criticism Of MMT, And Common Ground

Needless to add, there much criticism of MMT from mainstream economists. Palley, for instance, argues that much of what is right about MMT is old and known, and much of what is new is wrong.

In particular, he argues that persistent money-financed budget deficits as suggested by MMT would lead to inflation, except under very special conditions - such as in an economy that is consistently growing, where high-powered money stock grows at this growth rate.

Surprisingly, in India’s specific case, those that argue for and against MMT might find common ground under these special conditions. After all, as a young, underemployed emerging market, can we not aspire for sustainable high economic growth?

Also read: Covid-19: How Long Can India Inc. Hold Its Breath?

MMT and India Beyond Covid-19

Once the extraordinary conditions of Covid-19 pandemic and lockdown are behind us, the MMT policy prescription would be as follows. The government should spend to increase employment, without worrying about persistent fiscal deficits. In fact, Wray is a fan of employment guarantee schemes such as MGNREGA. But there is a catch.

Domestic output growth has to keep pace and meet the aggregate demand fostered by such spending. If it doesn’t, we’ll have too many Rupees chasing too few goods.

This will fan inflation and increase net imports. Financial instability – of the kind we saw in 2012 and 2013 – could then be just a short step away.

Interestingly, MMT critics such as Palley would have little disagreement with any of this. Their only refrain would be that there is nothing new or radical here, that all of this perfectly fit into post-Keynesian models. They might also warn, somewhat dourly, that the special conditions we seek could well be unattainable.

The alternative to increased domestic output would be for a large, sustained global demand for Rupees to emerge. The global thirst for U.S. dollars, for instance, allows the United States to get away with sustained conventional imbalances. However, even with steps such as inclusion of our local currency debt into global indices, such a status cannot be earned easily, and less so when our economy is weak. Over the past five years, we have averaged just around $3 billion of total foreign portfolio debt and equity flows into India each year.

Also read: One Contagion Is More Than Enough for India

Achilles Heel – Job Creation And Output Growth

Experts across the ideological divide thus agree on the need for India to create jobs and achieve output growth. Without these, high government deficits or even credit growth could lead to inflation and currency instability. Did we really need experts to tell us this?

The creation of jobs and sustained domestic output growth has been our Achilles heel for decades now. Periods of high growth have often been accompanied by rapid growth in inflation, imports, and current account deficit.

Job creation and output growth at least partly explain why China is able to sustain more than twice India’s total debt, as a percentage of GDP.

As things stand, many issues still come in the way of us achieving sustainable job creation and domestic output growth.

First, our financial sector ecosystem, the engine to fund our growth, is broken. It will take a further battering through Covid-19, and chunks of it will need rescuing. We cannot kick the can down the road any further. The ecosystem is crying out for repair and reform.

Second, and linked to the first, several sectors of the economy such as power, real estate, aviation and shipping, and telecom are chronically stressed. Here too, an ostrich-style denial hardly helps. As with financial services, these sectors need repair and reform.

Third, we have to improve the real on-the-ground ease of doing business, so that entities capable of investing actually consider fresh jobs and output in India. Factor reforms of land, labor, capital, and ease of contract enforcement are needed.

Finally, we need education, healthcare, and nutrition. Not because these will guarantee jobs for our children, but because they will offer them the best bet to navigate this world of rapidly changing geopolitics, economics, and technology.

All of this is easier said than done. This would require a serious overhaul of the economy, of a kind that we haven’t seen since 1991.


MMT would allow for sustained large fiscal deficits – of the kind many of us would love to see now. But there is no free lunch, even under MMT. Unless an unlikely large global demand for Rupees emerges, the increased spending has to be matched by a real increase in domestic output and jobs. If we were to meet these conditions, conventional economics would actually converge with the MMT prescription.

Even before Covid-19, the economic context was hardly conducive for achieving job creation and sustainable growth. The less confident we are about changing this narrative, the less we can afford to stretch our fiscal imbalance – even under MMT.

Ananth Narayan is Associate Professor - Finance at SPJIMR. He was previously Standard Chartered Bank’s Regional Head of Financial Markets for ASEAN and South Asia.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.

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