Law or no law, deficits keep getting monetised–Times of India

Clipped from:

A report in the 27th May edition of Times of India says that the union government is considering the option of getting the Reserve Bank of India to monetise its deficit in the second half of the current financial year.

Monetising the deficit, to put it roughly, is tantamount to the central bank creating money to help the government meet its expenditure.

This was the practice for many decades. However, from the mid-1990s till the Fiscal Responsibility and Budget Management Act was legislated in 2003, a series of steps were taken to end the practice of monetising the deficit.

But all that happened was that these legislative measures only ended the practice of overt monetisation of the government’s deficit. Implicit monetisation continued and was not necessarily restricted to adverse macroeconomic moments. 

Implicit monetisation can be achieved through the use of RBI’s customary liquidity tools such as open market operations (OMOs). This has happened at different points in time over the last decade.

In addition to OMOs, there are other ways to implicitly monetise deficits. Perhaps the most insidious of monetisation episodes took place in 2008.

In June 2008, RBI introduce Special Market Operations (SMOs) which allowed PSU oil companies to sell bonds to it in order to raise foreign exchange. These bonds were originally issued to the PSUs by the government as an alternative to reimbursing them in cash.

Therefore, by raising money from RBI by using these bonds, what took place was an indirect form of monetisation by the central bank.

Coming to the current situation, we have had RBI unleash waves of liquidity over months to improve monetary transmission. Is there a collateral outcome of RBI’s liquidity deluge?

Yes, and that is it helps the government’s borrowing programme.

That was explicitly stated by the last RBI governor Urjit R. Patel in an essay written for the Indian Express on April 28th.

Patel wrote: “The primary effect of excessive liquidity has, instead, been to monetise government’s expenditures and keep its borrowing cost low.”

All of this begs the question, why bother with overt monetisation through legislative changes when it is anyway being done implicitly?

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