Monetization of Deficit, Helicopter Money and Quantitative Easing

Dr Santosh Kumar Mohapatra*

 

The coronavirus has not only triggered health crises but also mammoth economic crisis and humanitarian crisis of gargantuan proportion. The coronavirus-hit world economy is falling deeper and deeper into a chasm with each passing day. The pandemic looks to inflict the worst blow to global economy in terms of contraction of growth, destruction of jobs and livelihoods since the great depression in the 1930s.

Indian economy is in tailspin and doldrums. As for GDP growth, it slipped to 3.1 per cent in the January-March quarter of 2019-20, dragging India’s growth rate for the whole fiscal year to 11-year low of 4.2 per cent, way below the government estimate of 5 per cent despite factoring in just one lockdown week as the national lockdown started on March 25. The core sector growth in April was contracted by a whopping 38 per cent, when the country was under full lockdown. The shrinkage of GDP and rise of unemployment to 27.11 percent in May 3, 2020 have raised the possibility of the worst ever recession since Independence.

With gradual shifting of lockdown or unlocking of economy, policy strategy has to be shifted from containment of corona virus to mitigation of its spreading and impact. Both lives and livelihoods are to be sustained and maintained. The need of the hour is to provide more aid and assistance to people and restart the sagging economy, ensure food security for all, strengthen the fragile health infrastructure, sustain job security, prevent retrenchment, and support the workforce in the unorganised sector. The priority should be given to provision of health and corona testing facilities swiftly at cheaper rate so that the people can live with corona without fear.

Sharp fall in the latest growth estimates is a wake-up call to government to ramp up (a large increase in activity or in the level of something) its stimulus package. In an interview to a national financial daily, former chief statistician Pronab Sen tells that the resource crunch of the Centre is over-stated and it should now come out with more stimulus package to spur the economy. GDP is likely to contract 10.8 per cent without more fiscal stimulus.

For this huge government spending (i.e, say above Rs 12 lakh crore) is necessary to boost economy reeling from Covid-19 pandemic driven contraction. But from packages of Rs 20.97 lakh crore declared by government in 5 tranches, fiscal outgo or expenditure by government will be around Rs 2.5 lakh crore which also includes the allocation of Rs 1.70 lakh crore before Prime Minister’s announcement on May 12, 2020.

A large part of packages accounts for liquidity-boosting measures by RBI. The entire stimulus package rests on the assumption that credit flow from financial intermediaries will elevate the economy. But this will only happen when businesses are no longer cramped by patchy transport and inter-state barriers and fettered movement of labour and people.

The formidable task is now how to finance the ballooning expenditure when tax collection receding due to sinking economic activities. More worrying is the fiscal deficit, which has gone up mainly due to poor revenue collection. It is noteworthy, while presenting budget for 2020-21, it was found that in revised estimate for 2019-20, gross tax revenue had fallen by Rs 2.98 lakh crore , while net tax revenue by Rs 1.45 lakh crores and total expenditure by Rs 88,000 crore over the target kept in budget 2019-20. Data released by the Controller General of Accounts showed that tax revenues further fell short by nearly Rs 1.5 lakh crore from the revised estimate again with fiscal deficit escalating to Rs 9.36 lakh crore in 2019-20 as against the revised estimate of Rs 7.67 lakh crore. Fiscal deficit has gone up to 4.6 per cent way above the revised target of 3.8 per cent.

As the government fails to finance its increasing spending either through tax or non-tax revenues, it will run huge fiscal deficit (excess of expenditure over non-borrowed receipts) in 2020-21 too. The conventional budget deficit had been phased out since 1997-98. It is pretty clear that the government will not be able to achieve its 2020-21 fiscal deficit target of 3.5 per cent of GDP. On May 9, the government revised its estimated market borrowings to Rs 12 lakh crore from Rs 7.8 lakh crore as announced in Budget 2020-21.

However, the rise in borrowing is inadequate to raise additional resources and gets counterbalanced as there will be shortfall of revenue by minimum Rs 3 lakh crore in 2020-21. Sadly, government seems to be a prisoner of its own fiscal fundamentalism, where government fears to raise fiscal deficit as same will make finance capital unhappy. Further, government has to contain its fiscal deficit so as to adhere to its fiscal rectitude and borrowing should be within repayment capacity.

However, it is generally accepted worldwide that the main method of financing the fiscal deficit is debt (internal or external) which are known as debt financing. But debt has to be repaid by government. Further, if debt does not lead to growth and fails to add sufficiently to the future revenue stream, it may be difficult to meet future obligations and government may fall in to debt trap. In present times, higher borrowing to finance escalating deficit is unwarranted. It may lead to serious debt crisis.

In an e-mail interview to PTI ( 15 April 2020) Fitch Ratings Director (Sovereign Ratings) Thomas Rookmaaker said India’s debt-to-GDP ratio is likely to rise to 76 percent from 70 percent currently due to wider fiscal deficit and low economic growth. In reality, with precipitous decline in GDP growth, it is likely to exceed 80 per cent. According to Fitch Ratings, rise in debt-GDP ratio will weaken credit profile.

Hence, other options are monetisation of spending or the creation of new money. The “monetization of spending” can be done through two ways. One such strategy is directly finance the fiscal deficit known as monetization of deficit or money finance or debt monetisation and another is “helicopter money”.

In her interview to a newspaper recently, the finance minister said that she is keeping her options open on monetisation of the deficit by the Reserve Bank of India (RBI). Much before this debate surfaced in media after coronavirus invasion, the author has written in social media advocating the monetisation of spending.

Now, former RBI governor C Rangarajan, Bimal Jalan former finance minister Yashwant Sinha, Kerala finance minister Thomas Issac, Nobel laureate Abhijit Banerjee and Esther Duflo, former chief statistician Pronab Sen advocate that the RBI should partly monetise the government’s fiscal deficit to meet  increasing expenditure especially when  tax revenues severely affected. In past Keynes (1933), Abba Lerner (1943), ex-chairman of the US Federal Reserve Ben Bernanke (2002) had advocated raising resources by above methods in time of recession.

The monetisation of deficit can meet the increasing spending needs of the government and provide for targeted fiscal stimulus possibilities without increasing public debt. In layman’s language, monetisation of deficit means printing more money. In other words, monetisation of deficit happens when RBI buys government securities/bonds directly from the primary market to fund government’s expenses or financing this debt by printing more money.  The government has to repay same to RBI. The RBI also sells those securities in the market.

According to Former RBI governor, D Subbarao, “Monetisation of the deficit” does not mean the government is getting free money from the RBI. If one works through the combined balance sheet of the government and the RBI, it will turn out that the government does not get a free lunch, but it does get a heavily subsidised lunch. That subsidy is forced out of the banks. And, as in the case of all invisible subsidies, they don’t even know.

The monetisation of deficit is also known as “seigniorage financing of deficits “—the profit the central bank makes as the monopoly provider of fiat currency. Fiat currency is legal tender whose value is backed by the government that issued it. Seigniorage usually results in windfall profits for central banks and governments. Seigniorage is a term for the profits governments make by issuing currency.

It is the difference between the face value of a currency note or coin, and its actual production cost. For instance, if the cost of printing an Rs 1000-note is about Rs 4, printing one such note and putting it into circulation fetches a profit of Rs 996. Usually central banks ‘earn’ this profit and transfer it to the Government. Though government has to repay the credit received from RBI through monetisation of deficit, it gets higher dividend too as RBI’s “seigniorage” profit increases.

In other words, RBI prints currency and give credits to government. New money can be transmitted through established fiscal policy channels to areas where it is most needed. This is to some extent similar to open market operations (OMOs) and Quantitative easing (QE) practised by the US, Japan, the UK, and in the Eurozone.

Though , monetisation , open market operations , Quantitative easing (QE) involve printing of money by the central bank, in case of monetisation of deficit,  central bank buys huge amount of government bonds from primary market, while in case of open market operations, Quantitative easing (QE)  it indirectly buy government bonds in the secondary market,  (i.e., from banks ). In return, it issues credit to the banks’ reserves. The primary market is where securities are created, while the secondary market is where those securities are traded by investors.

Open market operations are the sale and purchase of government securities and treasury bills by RBI or the central bank of the country. The objective of OMO is to regulate the money supply in the economy. When the RBI wants to increase the money supply in the economy, it purchases the government securities/bonds from the market and it sells government securities to suck out liquidity from the system. RBI carries out the OMO through commercial banks and does not directly deal with the public.

Quantitative easing (QE) is a lot like open market operations, increases the money supply, but on a much bigger scale. Instead of just buying small amounts of short term government debt to nudge interest rates down, QE is about buying huge amounts of different financial assets, so that central bank not only putting more money into the economy but also propping up sectors that are on the verge of collapse by buying them out. The difference is with QE the amount of money to be created is specified in advance and it’s a massive quantity (hence “quantitative”).

With normal OMO there is a target for the interest rate on government bonds and bonds are purchased by the central bank with newly created money until the low interest rate is achieved as money supply leads to low interest. However, a major problem with using interest rates to stimulate the economy is that it’s fairly difficult to reduce them below zero.

A negative interest rate basically means that lenders have to pay borrowers—instead of the other way around—which isn’t something economists expect to happen very often. But, hence, when interest rate cannot be reduced further, then quantitative easing is resorted. Some countries did a lot of this in 2008, to try and decrease interest rates, and get more investment going. And it worked—sort of. Over the past decade, quantitative easing has involved the Federal Reserve massively expanding its balance sheet from US$800 billion in 2008 to US$4 ¼ trillion by 2016. The Fed did so by aggressively buying US Treasuries and mortgage-backed securities in the secondary market.

Other option is “helicopter money”, an unconventional monetary policy tool devised by Milton Friedman who used the term “helicopter money” to signify “unexpectedly dumping money onto a struggling economy with the intention to extricate it out of a deep slump. It involves printing money by RBI and distributing same to the public by government with the aim of boosting demand and inflation.

It is just like a helicopter dropping money from the sky. According to some analysts, Japan is resorting to basically a type of helicopter money only. New Zealand government is also planning “helicopter money” handouts to stimulate economy. Recently, Telengana Chief Minister K C Rao advocated for helicopter money on the plea that it would help states to come out from economic morass triggered by Covid-19.

In present crisis, helicopter money is more preferable because resources raised by government through monetisation of deficit are to be repaid by government to RBI. But in case of helicopter money, it is basically non-repayable. However, the distinction between quantitative easing and helicopter money is far from semantic. Helicopter money is more preferable to quantitative easing too. Quantitative easing can distort credit allocation may trigger boom-bust cycle, exacerbate wealth and income inequality.

By contrast, helicopter money will not distort asset and credit markets but minimize the risk of any boom-bust cycle. If wisely deployed, it can ameliorate income and wealth inequality and raise purchasing power of people. However, while resorting to helicopter money or debt finance, union government should transfer a larger portion of funds to state so that they can undertake developmental works and adhere to fiscal discipline. Fiscal digression should be allowed in case of union government only. States should be funded so adequately that, it will never feel shortage of resources while tackling impact of Coronavirus.

However, printing notes is not same as printing dollars, and the yen as those are reserve currencies. They activated the printing of notes in the wake of the 2008 crisis for survival; they have intensified it now.  Similarly, unlike the US dollar, Indian rupee is not considered a safe haven. Even when the US Federal Reserve prints more currency, there is still global demand for the US dollar. However, the same will not be the case for the rupee. Thus, when there is excess supply of the currency, it could lead to a fall in rupee value, leading to an outflow of foreign investment.

It is further argued that both “monetization of deficit” and “helicopter money” are considered as government’s profligacy and India had abandoned it in 1997 as both lead to higher inflation though enhancing money supply. Before 1997, the fiscal deficit was automatically monetised through the issue of special securities called ad-hoc Treasury Bills, issued by the RBI on behalf of the Centre to itself at a fixed rate.

That practice ended in 1997 with a landmark agreement between the government and the RBI. Two agreements were signed between the government and RBI in 1994 and 1997 to completely phase out funding through ad-hoc treasury bills. And later on, with the enactment of FRBM Act, 2003, RBI was completely barred from subscribing to the primary issuances of the government from April 1, 2006.

It was also agreed that henceforth, the RBI would operate only in the secondary market through the OMO route. The implied understanding also was that the RBI would use the OMO route not so much to support government borrowing but as a liquidity instrument to manage the balance between the policy objectives of supporting growth, checking inflation and preserving financial stability.

But an escape clause will enable it to do so. Former Reserve Bank of India (RBI) governor Usha Thorat , on  May 2020, said if necessary the government could use the escape clause in the Fiscal Responsibility and Budget Management (FRBM)  Act, which allows the central bank to monetise the deficit. The Act as amended in 2017 contains an escape clause which permits monetisation of the deficit under special circumstances on the grounds that there just aren’t enough savings in the economy to finance government borrowing of such a large size. The case is made when Bond yields would spike so high that financial stability will be threatened. The RBI must therefore step in and finance the government directly to prevent this from happening.

Actually, it normally does not go down well with market as it enhances the power of state. Further, this method may not be applicable when economy is in good condition. But now when deflationary spiral, imminent recession, lack of demand is plaguing economy, those methods of raising resources should be adopted as it will not lead to inflationary spiral. But putting extra money on system should be gradual. Even, some amount of inflation is always preferable to rising hunger, starvation, poverty and unemployment.

 

 

The author is an Odisha-based columnist/ economist and social thinker. Email: [email protected]

 

 

DISCLAIMER: The views expressed in the article are solely those of the author and do not in any way represent the views of  Sambad English.

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