UPSC CSE Mains Syllabus: GS-3- Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment
Recently, Moody’s Investors Service (“Moody’s”) downgraded the Government of India’s foreign-currency and local-currency long-term issuer ratings to “Baa3” from “Baa2”. It stated that the outlook remained “negative”.
The latest downgrade reduces India to the lowest investment grade of ratings and brings Moody’s — which is historically the most optimistic about India — ratings for the country in line with the other two main rating agencies in the world — Standard & Poor’s (S&P) and Fitch (see attached chart on the brief history of India’s sovereign rating).
| Monetised deficit is the monetary support the Reserve Bank of India (RBI) extends to the Centre as part of the government’s borrowing programme. In other words, the term refers to the purchase of government bonds by the central bank to finance the spending needs of the government. Also known as debt monetisation, the exercise leads to an increase in total money supply in the system, and hence inflation, as RBI creates fresh money to purchase the bonds. The same bonds are later used to bring down inflation as they are sold in the open market. This helps RBI suck excess money out of the market and rein in rising prices. |
India’s economic woes:
- The Indian economy is expected to contract by 3.2% in this fiscal yearas a result of the COVID-19 pandemic and its associated restrictions, the World Bank said in its Global Economic Prospects (GEP) June 2020 report released on Monday.
- Growth is forecast at 3.1% next year.
- The combined fiscal deficit of the Centre and the States is expected to be in the region of 12% of GDP.
- Moody’s expectsIndia’s public debt to GDP ratio to rise from 72% of GDP to 84% of GDP in 2020-21.
- The banking sector had non-performing assets of over 9% of advancesbefore the onset of the pandemic.
- Weak growth and rising bankruptcies will increase stress in the banking sector.
Government’s fiscal measures so far:
- Reassuring the financial markets that the fisc will not spin out of control.
- It has kept the ‘discretionary fiscal stimulus’ down to 1% of GDP.
(‘Discretionary fiscal stimulus’ refers to an increase in the fiscal deficit caused by government policy as distinct from an increase caused by slowing growth, the latter being called an ‘automatic stabiliser’ ).
Still concerns remain:
- Keeping the fiscal deficit limited addresses the concerns of rating agencies about a rise in the public debt to GDP ratio.
- However, their concern about growth remains.
- The debt to GDP ratiowill worsen and financial stress will accentuate if growth fails to recover rapidly.
- The government’s stimulus packagerelies on the banking system to produce growth.
- The role of the banks is limited.
- More government spending is required, especially for infrastructure.
Impacts of monetary deficit:
- Monetisation of the deficit increases the discretionary fiscal stimuluswithout increasing public debt.
- The central bank typically funds the government by buying Treasury bills.
- When the government spends the extra funds that have come into its account, there is an increase in ‘Base money’, that is, currency plus banks’ reserves. Monetisation results in an expansion of money supply.
- But that is not the same as printing currency notes.
Objections: The main objection to such a stance is it may create inflation.
Is the objection valid:
- Current economic condition – Aggregate demand has fallen sharply and there is an increase in unemployment.
- In such a situation, monetisation of the deficit more likely to raises actual output closer to potential output without any great increase in inflation.
- Government usually incurs expenditure by issuing bonds to banks. Instead it could directly issue these to the central bank.
- As per Modern Monetary theory both creates same level of expansion in base money.
- Central banks worldwide have resorted to massive purchases of government bonds in the secondary market in recent years, with the RBI joining the party of late.
- These are carried out under Open Market Operations (OMO).
- The impact on money supply is the same whether the central bank acquires government bonds in the secondary market or directly from the Treasury.
Way ahead:
- As long as inflation is kept under control,it is hard to argue against monetisation of the deficit in a situation such as the one we are now confronted with.
- We now have a way out of the constraints imposed by sovereign ratings.
- The government must confine itself to the additional borrowing of Rs. 4.2 trillion which it has announced.
- Further discretionary fiscal stimulus must happen through monetisation of the deficit.
- That way, the debt to GDP ratio can be kept under control while also addressing concerns about growth.
Source:” The Hindu “.
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