1. With the economy stalled, there isn’t enough money in the market for the government to borrow. Can govt. ask the RBI to print more money?

  • How are govt. and RBI trying to boost the demand?

  • Why there isn’t enough money in the market for the government to borrow?

  • What is “direct” monetisation of deficit?

  • Then, why does the government not ask the RBI to print new money?

UPSC Can list these questions under

GS paper 3 ( Indian Economy )

What is the context about?

  • This is the most common doubt that everyone gets and occasionally during crisis time like this when the Coronavirus outbreak is hitting the country’s economy.
  • Most estimates suggest that India’s GDP (gross domestic product) will barely grow in the current financial year.
  • The government’s finances were already overextended going into this crisis, with its fiscal deficit way over the permissible limit.

What can be done to boost demand?

  • With a nationwide lockdown, incomes have fallen and so have consumption levels.
  • People need to have money. But, of course, who will give them money.
  • From the highest-ranking CEOs to stranded workers, incomes have taken a huge hit, if not completely dried up.

How are govt. and RBI trying to boost the demand?

  • For its part, the Reserve Bank of India (RBI) has been trying to boost the liquidity in the financial system. It has bought government bonds from the financial system and left it with money.
  • The government’s finances were already overextended going into this crisis, with its fiscal deficit way over the permissible limit.

Why there isn’t enough money in the market for the government to borrow?

  • For the government to borrow the money, the market should have it as savings. Data show that savings of domestic households have been faltering and are barely enough to fund the government’s existing borrowing needs.
  • Foreign investors, too, have been pulling out and rushing to “safer” economies like the US, and are unwilling to lend in times of such uncertainty.
  • Moreover, as the government borrows more from the market, it pushes up the interest rate.
  • So there isn’t enough money in the market for the government to borrow.

What is “direct” monetisation of deficit?

  • Imagine a scenario where the government deals with the RBI directly — bypassing the financial system — and asks it to print new currency in return for new bonds that the government gives to the RBI.
  • Now, the government would have the cash to spend and alleviate the stress in the economy.
  • In lieu of printing this cash, which is a liability for the RBI (recall that every currency note has the RBI Governor promising to pay the bearer the designated sum of rupees), it gets government bonds, which are an asset for the RBI since such bonds carry the government’s promise to pay back the designated sum at a specified date.

Has India ever done this in the past?

  • Yes, until 1997, the RBI “automatically” monetised the government’s deficit. However, direct monetisation of government deficit has its downsides.
  • In 1994, Manmohan Singh and C Rangarajan, then RBI Governor, decided to end this facility by 1997.

Then, why does the government not ask the RBI to print new money?

  • Direct monetisation of deficit is a highly contested issue.
  • qIdeally, this tool provides an opportunity for the government to boost overall demand at the time when private demand has fallen — like it has today. But if governments do not exit soon enough, this tool also sows the seeds for another crisis.
  • If the government doesn’t stop in time, more and more money floods the market and creates high inflation.