India is in the midst of an economic crisis. For every similar situation India faces, everyone precisely has these three suggestions for the government,
- The government should reduce interest rates.
- The government needs to spend more money.
- And if the first two don’t work, print more money for the government to spend.
Having taken the first two measures, is it time for the government to relive the moments from the hit Spanish TV show Money Heist and just print money? It’s easier said than done.
But first let’s first understand the tax inflow of our beloved government and how it has been impacted in the current situation ;
- Massive drop in consumption and production of non-essential items >>> Leading to lower excise and GST collection.
- Almost negligible foreign trade except for crude, medicines and PPE kits >>> Leading to a collapse in customs duty collection.
- Lower fuel consumption >>> Lower excise duty collection
- Minimal real estate and vehicle sales >>> Minimal registration collection
- Alcohol shops are shut too (Doesn’t matter for Bihar and Gujarat though)
However, the recent spike in fuel excise duty and sales tax is expected to offset some damage to the centre and state.
At situations like these when the private sector consumption is at an all time low, the government is expected to be the “spender of last resort”, and as the name suggests, start spending to get the economy back in track.
But where does the government get the money to spend?
On usual circumstances, it borrows by selling bonds to banks, insurance companies, mutual fund houses, etc. However, taking the COVID situation into account, this leaves out the private sector with very little money, which will result in higher interest rates.
Recommendation – Print money (not literally, but create digitally)
But does it work?
In order to print money, the government sells bonds to RBI (basically borrows money from RBI) and then RBI prints the money and gives it to the govt.
But is it as simple as it sounds? Everyone, from journalists to corporate biggies to Mango people, wants the govt to print money. They all think of the process of spending and printing as almost a free lunch. BUT THERE IS NO FREE LUNCH IN ECONOMICS (discussed later).
Now let’s dwell deeper on the economics of money printing, on the back of the concept of Modern Money Theory (MMT)
- Government issued currency is called Fiat Money. A currency is termed fiat money when it is not backed by any physical commodity like gold, silver, etc. and most currencies today are so. Even bitcoin can be called fiat money for the same reason.
Fiat money only holds value because the government backs it as a legal tender. So, if tomorrow Modiji announces a Phase 2 of Demonitisation wherein they would accept only USD, INR will then hold no value because it’s not backed by any physical commodity. The stability of a government and economy also plays a key role in the valuation of a currency. Iranian Rial (1$ = 42,000 Rial) is the cheapest currency in the world for similar reasons.
2. MMT also argues that a government can never go bankrupt simply because they can always print and pay their dues.
3. MMT states that government while being the spender of last resort is also at the same time being the employer of last resort. Print >>> Spend >>> Employ >>> Economy revived.
4. While we earn and spend money in INR we also pay our taxes in INR, only because the govt has the right to taxes and only so in govt tender INR
5. The value of every currency is also derived from it’s demand and supply. While excess printing/supply can reduce the value and create inflation (but not always, we’ll come to that later), the government needs to always prop up the demand.
One of the ways the govt props up the demand is by accepting taxes in INR. The tax received by the government is again spent and used for employment. While this works wonders in developed economies, not so much in developing economies like India where paying taxes honestly, is not really the order of the day. The tax avoidance and tax evasion which is so prevalent in the country hampers this logic.
6. Money Printing leads to inflation, we’ve all learnt this in school. But what we’ve not learnt is that this logic doesn’t always apply, especially in today’s economic scenario. How is that?
The logic behind this is that, when the government prints money there is a higher amount of money (higher demand) chasing the same number of goods (same supply), which leads to inflation (increase in prices). But as of today, the capacity utilization of most manufacturing companies is somewhere close to 70% and the private consumption is badly hit. Thus higher demand will lead to companies increasing supply by tapping the unutilized capacity, thus not leading to an increase in prices. (Advantage !!!)
Let’s go a little further into the flow of printed money in today’s economy, RBI Prints and buys government bonds >>> Governmnt sells bond and generates cash >>> Governement Spends (Purchases) >>> The sellers to the government receiving cash, spend further on and deposit the balance money with banks >>> The banks deposit the money with RBI for interest >>> RBI pays interest.
Now, in normal circumstances the banks would’ve rather lent the money out to public at higher interest rates and generated liquidity for all. But the banks are reluctant to lend to public at such difficult times to avoid NPAs, thus they rather deposit the money with RBI at a rather low interest rate of 3.75% (also known as reverse-repo rate). The RBI ends up paying interest for the money they’ve printed, which also goes on to prove what was said earlier that there is no free lunch in economics.
7. Money printing naturally also has exchange rate impacts. Too much printing and spending can depreciate the INR especially when foreigners decide to sell their assets in INR, which will result in a run for USD and dumping INR and thus depreciating INR.
8. As noted earlier, the RBI prints and buys govt bonds which technically means the government takes a loan. Too much of printing can lead to excessive unserviceable loans which could lead to rating agencies downgrading India, and hence again, foreign investors making a run for their money and depreciating INR (previously explained)
9. We ultimately also have to understand the value of INR in comparison to USD or any other developed currency for that matter. There is always an undying demand for USD around the world which enables the FED to print USD without many negative consequences, whereas the same can’t be said about RBI printing INR.
We have absolutely no role to play in the decision to print money or not. It is a decision the govt would be taking after detailed analysis and consultation with economists (or so I hope) but I just thought it would be interesting to know about it from a bird’s eye view. Thus sharing it.
I tried to make it as simple and on point as much as possible. If you find this little summary interesting you can read the original article here. If not, I just saved 15 min of your life.