Government revenues from excise and GST have fallen dramatically due to a sharp decline in the consumption of non-essential items. Customs duty is also taking a hit because of reduced foreign trade. With private sector taking a huge hit, the government is expected to spend money and get the economy back on track. But where will this money come from? If the government borrows money, it will lead to increase in the interest rates, making it very difficult for the private sector to borrow money while it is already struggling with declining profitability. Hence it is best for the government to avoid borrowings in the current scenario.
It looks like, the only option now left is to print money. Let’s understand how its done.
The government deals with the RBI directly in this case. It issues bonds and the RBI buys these bonds. Where does RBI get this money from? It creates the money from thin air by simply printing it. This money is lent to the government or, in other words, placed in the government’s account at the RBI.
As easy as this whole money printing theory might sound, there are other factors that need consideration before finally taking a call on whether or not to print money. Let’s look at them point-wise.
Recently government announced that it will deposit Rs. 500 per month in Jan Dhan bank accounts of women for 3 months. Let assume that money is printed and the same amount is also deposited into men’s account. As they spend money, this money will land up with shopkeepers. After holding back some of this amount depending on their need, most of it will be deposited by shopkeepers in their bank account. Given the current scenario, banks are unwilling to lend. Instead, they are depositing the money with the RBI under reverse-repo. What this basically means is, the money that the RBI is printing is coming back to it and it has to pay interest on it (reverse repo-rate). Also, since the RBI is incurring an additional interest expense, it will cut down on its dividend payment to the government.
As of May 5, the total amount of money deposited by banks with the RBI through the reserve repo window stood at Rs 8,53,282 crore. On February 20, just two-and-a-half months back, the banks had deposited just Rs 39,983 crore with RBI under the reverse repo window. This simply shows the reluctance of banks to lend. To address this issue, recently, the Monetary Policy Committee (MPC) has reduced the repo rate from 4.4% to 4.0%. Also, the reverse repo rate which was 3.75% has been reduced to 3.5% so as to discourage the banks to deposit money with the RBI and instead lend. Both of these reductions are meant to increase the money supply in the economy, which the banks are otherwise keeping as deposit with the RBI.
To add to the above point, even if the RBI prints money, it doesn’t change the fiscal scenario (overall debt) of the government. If the credit rating agencies feel that government debt is rising to unsustainable levels, they are likely to downgrade India’s rating. If that happens, there will be a huge sell-out by the foreign investors.
In the normal scheme of things, the government sells bonds to finance its deficit. These bonds are bought by banks. Currently, the return on 10-year government bonds is around 6%. So, if the banks hold on to these bonds till maturity, they are likely to earn 6%. In a money printing scenario, these banks are earning a mere 3.50% on their deposits to the RBI which is reducing their profitability which in turn reduces their tax payments (in case of both, private banks and private sector banks) and dividends (only in case of public sector banks, since the government owns them).
And finally, any hint of money printing by the RBI to finance government expenditure might lead to foreign investors leaving the country. They will sell out of the stock market, debt market, real estate market and convert the proceeds (Rupees) into dollars. This will increase the demand for dollars and lead to a depreciation in the value of rupee against dollar. If this happens too quickly, it can lead to a currency crisis.
As we can see, that there are no simple solutions to these complex issues we face. The government will have to use a combination of borrowings, money printing and reduction in interest rates to increase the money supply and get the economy back on track.
Credits: Vivek Kaul’s article – Should the RBI print money to revive the economy? It’s not as simple as it sounds