DEBT MONETIZATION

monetization and coronavirus

Written by Harnisha Patil

May 27, 2021

Debt monetization or monetary financing or monetizing the deficit is the Government borrowing money from the central bank (RBI) to finance public spending instead of selling bonds to the private sector or raising taxes. It is often informally and pejoratively called printing money or money creation.

In other words, RBI gives direct debt to the Government by purchasing government securities directly from the Government.

RBI does debt monetization by purchasing government securities directly in the primary market. Such a monetization process used to be automatic-only until 1997, when it was later decided to end this practice by allocating RBI to control such OMOs (Open Market Operations) only in the secondary market. An escape clause in the 2017 amendment of the FRBM (Fiscal Responsibility and Budget Management Act) act authorizes such direct monetization under exceptional circumstances.

Debt Monetization leads to a boost in money growth in alliance with interest rates, but not necessarily money growth regarding government purchases or OMO. Monetizing debt arises when changes in debt produce changes in interest rates.

But what’s unique about it is:

In regular times, Government borrows from the market by selling bonds.

In ‘financing the deficit time,’ RBI will print money for this debt.

Monetizing the Deficit and The Earlier Times

In both war and pandemics, one of the most significant calamities is government finances. The governments suffered from low tax revenues and increased their expenditure as both private investments and consumption have collapsed.

During the Wars, the governments often spend aggressively by engaging in something called deficit financing.

Even during WWII, the British authorities pushed into the war, but In 1935, RBI was established, and the function of banker to the Government was transferred from Imperial Bank to RBI. The RBI was committed to holding cash deposits of the Government, be the public debt manager, and provide financial help to the Government through Ways and Means Advances (WMA). Just after a few years, this function of banker to the Government was questioned due to WW-II.

The Indian Government was required to finance not just its defense expenditure but also raise resources for the unending inclination of the colonial authorities. However, the Government wasn’t able to raise resources in a non-inflationary manner. This was because of the ongoing fight for Indian independence and the complete lack of preparation for the war.

Earlier:

Automatic monetizing of deficit.

Through 91-day non-marketable ad-hoc treasury bills sold to the RBI.

1997:

WMA introduced (Ways and Means advances). It ensured the Government’s flow of funds and allowed the RBI to give short-term advances to the Government. The loan had to be repaid in three months.

2003:

FRBM Act, 2003 (Fiscal Responsibility and Budget Management) stopped this practice.

The Act blocked the RBI from participating in primary issuances of government securities from 1 April 2006.

How can it be done now?

Extreme times Clause:

RBI could sign up to the primary issue of central government securities in case the Government exceeds the fiscal deficit target on the grounds of:

– national security

– Act of war

– national calamity

– collapse of agriculture severely affecting farm output and incomes – structural reforms in the economy with unanticipated fiscal implications

– downfall in real output advancement of a quarter by at least three percentage points below its standard of the previous four quarters.”

Due to this, the possible implications will be:

1.      Inflation – The most significant concern

–        Slow monetary transmission and credit growth will mitigate the growth of newly printed money

–        Due to lockdown, there is a dramatic fall in inflation

–        Good inflation will boost taxes and wages.

2.      Devaluation of currency – which will lead to foreign investors to lose confidence and pull out money

–        Government doesn’t fund itself via direct external borrowings

–        Monetizing the deficit can take the economy faster towards recovery- lending to better corporate performance and making India lucrative for investors 

To sum up, India’s growth story needs to be driven by high productivity to start with, and then probably, printing money could do less harm.

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6 Comments

  1. Mayank Limkar

    Got to learn something New.Very
    well explained.

    Reply
    • Harnisha Patil

      thank you so much✌

      Reply
  2. Diya

    Brief and we’ll explained.

    Reply
    • Harnisha Patil

      thanks a lot diya ❤

      Reply
  3. Deepali

    Very useful. Explained in a simple language really helped to understand the topic.

    Reply
    • Harnisha Patil

      thank you so much

      Reply

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