The Hindu Business Line : Monetising the deficit

The use of sovereign power poses difficult choices because whether it has been used sensibly or not can be determined only after the event. The idea of monetising the fiscal deficit, which is gathering steam rather too quickly because the US has also decided to so, is a good example of this. Faced with having to stimulate the economy in the sharpest and worst downturn since 1929, governments have responded by cutting taxes and spending more. The former has, however, made t he latter harder because how do you spend more when you are earning less? That has forced governments to borrow more but, when gorillas walk on Main Street, others have to make way. This means that when governments borrow more from the market, they push up interest rates. For the private sector, this increase in rates can nullify, wholly or in good measure, the positive impact of the tax cuts. So the economy gains less than what is needed. If not exactly back to square one, it gets close to it. This is where sovereign power comes in. In this case, it is the power to print notes in order to finance the deficit. Should this power be used now? The answer depends on appreciating one essential fact: deficit monetisation is exactly like using steroids. Both help in the immediate context but both can create fatal dependencies.

India is no stranger to this phenomenon. It started monetising its deficits way back in 1956 and kicked the habit only in 1997. The economy grew at an average of 4 per cent per year during this period. Subsequently, a law (the FRBM Act) was passed to make it illegal to take this steroid. But even the strongest opponents of monetisation of deficits would agree that there may be no other way out now, especially if all the stimulus measures taken until fail. But that will not be known for another six months or so.

That could be one reason why the Government has announced its borrowing programme only for the first six months of the current fiscal — and at Rs 2,41,000 crore, it is almost 80 per cent of what it borrowed in the whole of 2008-09, which itself was Rs 1,65,000 crore more than it had budgeted. The question is: if by October the scope for borrowing more is exhausted, what will it do for the rest of the year? This is where it may have to print notes (monetise). In that sense, mercifully, the decision is still months away. If things begin to look up, the extent of monetisation may not be much. The Finance Commission is examining the issue and one must hope it provides the right answer.

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