Subject: Economics

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

For all the talks over the size of Atmanirbhar package, India’s response turns out to be inadequate when compared with the other countries with similar levels of per capita income. This article analyses the same.

Context

• India’s fiscal response is compared to countries which are similar in GDP per capita, state capacity, and structure of the labour force.
• Before the Atmanirbhar Bharat package, India lagged significantly behind comparable developing countries.
• As of early July, the gap seems to have narrowed.

Comparison and challenges

•  Due to the blurring of the distinction between fiscal and monetary components, ensuring comparable and accurate figures for fiscal responses is a challenge.
• For example, the total Atmanirbhar package is billed at 10% of GDP by the government.
• While the headline number for India’s fiscal response in international databases is around 4% of GDP.
• But some estimated that the new fiscal outlay is around 1.7% of GDP.
• Vietnam, Indonesia, Pakistan, and Egypt, all while averaging less stringent measures than those in India, have announced stimulus measures that are as large or more substantial, as a share of GDP.

Demand-side interventions in the package

• The one significant demand-side intervention in the Atmanirbhar Bharat package was ₹40,000 crore of additional outlay for the MGNREGA.
• Most other demand-side measures involve the frontloading, consolidation, or rerouting of existing funds.

How developing countries are financing responses

• Developing countries are resorting to drastic means to finance COVID-19 responses.
• Actions so far include the amendment of legal budget limits.
• Some are also exploring enhanced issuance of bonds-including a ‘pandemic bond’ by Indonesia.
• Central banks in many emerging economies are experimenting with purchases of public and private bonds in the secondary market (quantitative easing).
• Or some are directly purchasing government bonds on the primary market (monetising the deficit).
• In India, the debate continues over whether the Indian government should invoke the “escape cause” in the FRBM Act.
• Escape clause will enable the central bank to directly finance the deficit.

Cash transfer: Lessons for India

• Demand-side interventions announced by other developing countries could provide lessons for additional measures in India.
• Of the World Bank’s list of 621 measures across 173 countries, half were cash-based. 
• While only 2% related to public works, a clear indication of the popularity of cash transfers over public works for income support,
• Countries have also significantly expanded coverage of their cash transfer programmes from pre-COVID-19 levels.
• Bangladesh and Indonesia have increased the number of beneficiaries by 163% and 111%, respectively.
• Indonesia’s cash schemes now cover more than 158 million people or 60% of the population.
• Additionally, the Indonesia central government has directed village authorities to focus their budgets on a cash-for-work programme.

Suggestions for India

• India could take these actions about cash transfers into account in decisions about expanding existing transfer programmes or even creating new ones.
• India has been a leader in employment guarantee policies with its flagship MGNREGA programme.
• This is the right time to expand entitlements MGNREGA.
• There is a need to introduce an urban version of the MGNREGA.
• In India, one reason for the subdued fiscal response and the resort to monetary measures is a concern with the debt-to-GDP ratio.
• However, aggregate demand and confidence in the economy have slumped and may not recover for many months.
• Additional fiscal outlay -would save lives and jobs today and might prevent a protracted slowdown.

Consider the question “How India fares in comparison with other countries over its fiscal response to Covid? Also examine the utility of income support schemes related to public works against the cash transfer schemes adopted by the other countries.”

Conclusion

Not spending more now, therefore, might only worsen the debt-to-GDP ratio if growth remains depressed. The fiscal outlay in the form of cash and in-kind transfers and expanded public works schemes is the need of the hour.

Original op-ed:

https://www.thehindu.com/opinion/op-ed/the-covid-19-fiscal-response-and-indias-standing/article32154153.ece