Why India doesn't print a ton of money to fight poverty

 

Why India doesn't print a ton of money to fight poverty

Amitabh Tiwari

Yahoofinance

 

 

The coronavirus pandemic has pushed the world into a recession. Major global economies are responding to the COVID-19 induced recession by adopting unorthodox measures. 

The United States, the European Central Bank, Japan, and even emerging economies such as Turkey and Indonesia are printing money to bring economies back to life. 

However, India has refrained from doing so.

After the Q1 financial year 2020-21 GDP deceleration of 23.9%, the highest among major economies of the world, the chorus is growing in India for monetisation of the fiscal deficit: in layman’s language, printing more money to boost the ailing economy. Especially, because the repercussions of not spending to support the economy could be irreparable.

But before that, let’s understand a few things:

What is fiscal deficit?

Fiscal deficit is the difference between the total revenue or income of the government less its expenditure. 

For FY 2019-20, the central government’s receipts through income taxes, GST and other receipts were Rs 19.32 lakh crore, while its expenditure on schemes, subsidies, and infrastructure, interest payments were Rs 26.98 lakh crore. 

Hence, the fiscal deficit was Rs 7.66 lakh crore. It is expressed as a percentage of the GDP. The figure was 3.8% in FY 2019-20.

Take the case of an individual, if she spends more than she earns, how would she make up for the difference? Well, she would need to borrow, from friends or banks or moneylenders.

Similarly, the government also borrows money from the market to finance the fiscal deficit. It usually issues bonds which are subscribed by individuals and institutional investors. 

They lend money to the government with the promise of future payment. These bonds carry a lower rate of interest than what is available to corporates/individuals, as they are considered as risk free.

The central government has hiked the market borrowing for this year to Rs 12 lakh crore from Rs 7.8 lakh crore presented in the Union Budget in the wake of the coronavirus pandemic, implying fiscal deficit will shoot its target.

Why do governments spend more than they earn?

Politicians and policymakers rely on fiscal deficits to expand popular policies/schemes, such as welfare programmes and public works, without having to raise taxes or cut spending elsewhere in the Budget, to elicit support during elections.

What is monetisation of fiscal deficit?

Monetisation of fiscal deficit refers to the purchase of government bonds by the central bank, i.e. the Reserve Bank of India. 

Since the central bank creates fresh money by simply printing to buy these bonds, in layman’s language, monetisation of deficit means printing more money. This helps finance the spending needs of the government.

The government spends this money on infrastructure projects which creates jobs, having a multiplier effect on the economy. This money could be used by the government to provide more funds for its welfare schemes, NREGA, transfers to Jan Dhan accounts, etcetera which then provide a fillip to consumption, which has been badly hit by the pandemic. Consumption, both private and government, accounts for about 70% of India’s GDP.

That’s great. Why doesn't India just print tonnes of money and distribute to the populace to ensure nobody is poor? 

It’s not easy.

In the past when countries have tried to get richer by printing money it hasn’t worked. Printing more money increases money supply in the economy. Now everyone has more money, more money is chasing goods and services. This leads to an increase in prices as sellers take advantage of the situation and charge more.

This has happened earlier in Zimbabwe and Venezuela. The countries suffered from hyperinflation, in simple terms very high inflation. 

In Zimbabwe prices rose as much as 231,000,000% in a single year in 2008. The paper used probably became worth more than the banknote denomination printed on it.

Should the RBI then print money to revive the economy, especially when the stimulus package announced by the government is deemed insufficient?

Economists are divided on the issue: while some have cautioned against the move, others say limited monetisation can be undertaken given the extraordinary situation. 

The money received by the government from the RBI can be used to fund higher spending and protect the economy, the poor and vulnerable in these abnormal times.

High government borrowing from the market can raise interest rates and deny credit to the private sector, reducing the pool of money available to them, termed as crowding out.

Monetisation of fiscal deficit/printing of money can avert this situation but there are risks of high inflation and currency depreciation apart from a general deterioration in macroeconomic balance.

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A section of economists believes that emerging economies like India have far lesser room to support local economies than developed markets.

·         In the US, the Federal Reserve has expanded its balance sheet to $7.1 trillion, up from $4.4 trillion before the pandemic crisis hit.

·         The Bank of Japan has pledged unlimited purchases of government bonds and expanded its exchange-traded fund buying.

·         The European Central Bank has announced a $1.35-trillion asset purchase programme.

·         In contrast, most emerging market central banks, including India, are treading cautiously.

“Because of the peculiarities of the international monetary system, many so-called emerging economies simply don’t have the wherewithal or the institutional credibility to take the kind of financial risks that so many developed countries have done. If, for instance, an emerging country were to embark on the kind of fiscal expansion Japan has undertaken, markets might panic about that country. That is the reality." -- Jim O’Neill, Chiar, Chatham House

To sum up, it’s not an easy decision: one needs to weigh the pros and cons. Also, it's not just an economic, but a political decision as well.