Where is the money to fund economic revival?

India has been facing an economic slowdown for over two years now. There has been an almost consistent decline in GDP figures since the last quarter of 2017-18, when the growth rate was clocked at 8.2 per cent. The twin-impact of demonetisation and GST rollout was yet to plateau before the coronavirus pandemic brought economy to almost a halt.

Experts have been arguing for increasing investment in India to revive growth. With the fact that private investments have been sombre, at best, the onus has shifted to the government to raise public investment hugely. But the government has been facing a revenue crunch, also aggravated by the coronavirus pandemic.

In a nutshell, the government does not have enough money to pump into the system. Large scale borrowing has its own cyclic ripple effect. One way out that is being talked about is monetisation of the Centre’s deficit by the Reserve Bank of India (RBI).

This route has generated much interest following a State Bank of India (SBI) research paper that recently advocated that the RBI could monetise the Centre’s deficit at lower rates. This possibility was, however, officially played down by economic affairs secretary Tarun Bajaj last week.

The government is short on revenue. To bridge the gap, governments borrow money from the markets — pushing fiscal deficit up. Borrowing from markets usually takes place in the form of government issuing bonds. Given the prevailing financial sentiment due to the coronavirus pandemic, some experts doubt that the markets will be able to buy all the bonds that the government issues. This would pose a serious question of economic credibility.

To circumvent this possibility, the suggestion is that the RBI should buy bonds issued by the government — thereby monetising the debt or deficit by printing additional money to finance this debt.

This is an old model of debt/deficit financing but India forsook this approach in 1997 in favour of a system of ways and means advances (WMA). Under WMA, the RBI extends short-term loans for which limits are announced six months in advance.

These loans are fully payable within three months. Under the given economic predicament, this does not look like a feasible tool to finance economic recovery.

So, there is this talk about monetising the deficit. But this approach had its own demerits that prompted policy makers to abandon the practice in the first place. RBI monetising the deficit is bound to push inflation, a concern that the central bank has been very sensitive about in recent years. The RBI is mandated to keep inflation in the range of 2-6 per cent.

There is also a fear of unproductive government spending due to political compulsions.

A Bloomberg report on Sunday referred to excerpts from an upcoming book by former RBI deputy governor Viral Acharya. The report quoted from the book to voice his warning against the RBI monetising the Centre’s deficit.

Acharya has called this approach “deeply flawed” as it would be “regressing to the errors of the 1970s and 1980s”. There is another problem. The Fiscal Responsibility and Budget Management Act (FRBMA), brought in by the Atal Bihari Vajpayee government in 2003, restricts the RBI from buying bonds directly from the government.

This brings back to the root, still unanswered, question: where is the money to fund India’s economic revival?