Brief Notes on Monetised Deficit

We often come across news like GDP growth fell by some per cent or the GDP growth of this financial year went down by some per cent. So, what does it mean? Why does it happen? One of the major reasons for slow GDP growth or declining GDP growth is monetised deficit. It is a kind of a loan bond between the Central Government of India and the Reserve Bank of India (RBI). The monetised deficit increases the net RBI credit to the Central Government of India. 

Definition of monetised deficit 

Monetised Deficit is a term used to describe a deficit that has been monetised. The central bank purchases government bonds to fund government spending demands, known as monetised deficit.

A monetary deficit can meet growing government spending needs and provide an opportunity for targeted fiscal stimulus without increasing public debt. Making money from a deficit means printing more money in layman’s terms. A currency imbalance occurs when the RBI purchases government securities/bonds directly in the primary market to support government spending or print more money to pay for that debt.

The government must repay the same amount to the RBI. The RBI also sells these securities on the market.

Let us know about monetisation means.

When an asset or business earns revenue by selling services or goods, it is called the monetisation of the business or the asset. Examples include revenue through hotels, restaurants, toys, online subscriptions etc. So, this clears our monetisation meaning.

About monetised deficit

When the government goes under the pressure of loans and credits due to government projects or any disaster, the Reserve Bank of India helps the Central Government repay the loan or fight against the disaster through the monetisation of debt. The RBI provides monetary support to the government by purchasing their bonds. This is called a monetised deficit. Moreover, it affects the nation and its citizens in many different ways. 

There are two methods for “expense monetisation”. One of these strategies is to finance the budget deficit directly, known as deficit monetisation or monetary financing or debt monetisation, and another is “helicopter money”.

Around the world, the primary method of financing budget deficits is debt financing (internal or external), known as debt financing. On the other hand, the government is responsible for repaying the debt. Furthermore, if debt does not lead to growth and does not contribute enough to the future income, meeting future obligations may be problematic, and the government may fall into a debt trap. For now, borrowing more to finance the growing deficit is unwarranted. This could lead to a severe debt crisis.

Effect of monetised deficit 

When the Central Government asks for monetisation of debt from the RBI, the RBI starts printing more new money to meet the government’s demand. Moreover, it increases the flow and amount of money in the market. Ultimately, it results in inflation in the whole nation. Moreover, it also affects the import and export market. 

• Helicopter Money

Helicopter money refers to increasing the country’s money supply through more spending, tax cuts, or increased money supply. 

Some of the stimuli implemented in response to the COVID-19 crisis are similar to the concept of helicopter drop rates.

• Open Market Operations

The buying and selling of treasury bills and government securities by any country’s central bank to regulate the money supply in the economy are known as open market operations.

Central banks use this as one of their primary tools for monetary control. When the central bank wishes to reduce the money supply in the market, it sells securities in the market. This is done to raise interest rates. A restrictive monetary policy is another name for this programme.

When a central bank wishes to expand the money supply, it purchases securities on the open market. This step supports the country’s economic growth by lowering interest rates. This type of policy is termed expansionary monetary policy.

How can deficits be monetised? 

A government deficit is said to be monetised when the central bank buys bonds issued by the government to cover its deficit. Due to the identity of a central bank’s balance sheet, such purchases increase a bank’s reserves unless other transactions offset them.

Indirect monetisation of deficit

For now, indirect monetisation cannot eliminate direct monetisation, but it is the basis for the Centre to maintain its annual borrowing target of Rs 120,000. Direct monetisation of the deficit occurs when RBI purchases directly from the primary market to support Central spending.

Is monetisation of the deficit allowed? 

The RBI participates in indirect monetisation of deficits through open market operations, but the consequences of direct monetisation are much more significant. This can undermine the fundamentals of the country’s macroeconomics and carry the risk of downgrades from rating agencies, resulting in additional costs to the economy.

Conclusion 

The RBI provides monetary assistance to the government. Through Open Market Operations, the RBI participates in indirect deficit monetisation. Helicopter money and financing the budget deficit are two further ways to monetise loans.