Economic Indicators and Various Reports On It- GDP, FD, EODB, WIR etc

Gold and forex reserves cannot finance stimulus

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Debt monetisation, RBI balance sheet etc

Mains level : Paper 3-Ways to raise funds to finance the stimulus package

The article analyses the issues with suggestions like printing of currency and using forex reserves to finance the stimulus. They also lead to an increase in government debts.

Context

  • Prime Minister announced a stimulus package of 20 trillion to fight the economic fallout of the covid pandemic.
  • Since then, several unorthodox ideas have been floated to raise funds for it without straining government finances.
  • Among the suggestions are the printing of currency, and using foreign exchange reserves or household gold.

Let’s look at entries in the RBI’s balance sheets

  • On the liabilities side of it is the currency in circulation, commercial bank reserves  and government reserves.
  • On the asset side of it is forex reserves, government securities and gold.
  • The balancing item represents the central bank’s equity and accumulated surplus.

Let’s look at 3 options suggested above and issues with them-

1) Printing currency

  • Doing this would increase the liabilities of the RBI under “currency in circulation”.
  • But it first needs to acquire assets to offset this increase in liability.
  • These assets could be government securities, forex reserves or gold.
  • Thus, one way for the government to finance its expenditure would be to issue government bonds and ask RBI to print currency with which to subscribe to such bonds.
  • This is known as deficit monetization.
  •  It is important to note that for the central bank to print money, the government would have to issue bonds to it.
  • It will increase government debt.

2) Monetisation of gold held by household

  • This would first involve the government buying gold from households in exchange for its bonds.
  • Then, the accumulated gold would be bought by RBI from the government with newly printed currency.
  •  In this case, instead of creating new money to acquire government bonds, RBI would be doing the same to acquire gold.
  • This too involves the Centre taking on additional debt.
  •  Moreover, gold monetization schemes in the past have yielded only mild success.

3) Using RBI’s forex reserves

  • Against every dollar of forex reserves shown by RBI on the asset side, an equivalent rupee amount has already been created on the liability side.
  • This is because whenever RBI acquires foreign currency, it pays for it using the Indian rupee.
  • Thus, no additional currency can be printed against such already-acquired reserves.
  • The only way our forex reserves can be used for generating additional resources is by pledging them to a third party.
  • The pledging of RBI’s assets to raise funds is done only under extreme circumstances, for instance, during the 1991 balance of payments crisis.
  • We are certainly not in a situation that warrants a repeat of an exercise where RBI’s assets, be it gold or forex reserves, have to be mortgaged.

So, what is the way out?

  • There are only three ways to finance government expenditure: taxes, debt and asset sales.
  • Taxes and asset sales can pitch in a bit towards the stimulus bill.

Consider the question “Examine the ways in which government can raise the funds to finance the stimulus package and also discuss the issues with each move.”

Conclusion

There is no escaping the fact that we are staring at a higher build-up of government debt in the future. When we stop harbouring the notion that we can pay the stimulus bill without any deterioration in government finances, we will be able to see the bitter truth: There is no such thing as a free lunch.

Read more about the issue here:

India’s rising Forex Reserves

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Raj Kumar
19 days ago

what is stimulus bill?

Tamal Sau
19 days ago

your links to the source dont work for other websites apart from the hindu. Though it works fine on ur app. But this bug exists in ur web version