Gold and forex reserves cannot finance India's stimulus

Excellent study material for all civil services aspirants - begin learning - Kar ke dikhayenge!

 Gold and forex reserves cannot finance India's stimulus

---

Read more on - Polity | Economy | Schemes | S&T | Environment

---

• Rs.20 trillion package: The PM announced a stimulus package of Rs.20 tr to battle the economic problems post-COVID. How to finance it has been the question ever since, with many new ideas coming up regularly. Some suggest printing of currency, or using forex reserves, or using household gold. But they are not good ideas, and the fresh debt bill won't be erased by these.
• Central Bank balance sheet: The liability side of this is made up of currency in circulation, commercial bank reserves, and government reserves (state balances). The asset side has forex reserves, govt. securities, and gold. Then comes the balancing item of central bank's equity and accumulated surplus.
• Printing currency: The liabilities will rise, so assets are needed to offset it. They can be govt. securities, forex reserves or gold. So the government can issue bonds and ask RBI to print currency to subscribe to these. That is deficit monetisation, which was automatic till 1997, but then was stopped. 
• What next: Once RBI stopped subscribing to govt. bonds automatically, the govt. was forced to go to the open debt market. RBI could also buy from the markets only. So today, if this norm is bypassed, even then the govt. debt will rise as bonds have to be issued anyway. 
• Inflation: So if the govt. thinks it can keep debt low by issuing bonds to RBI (and not via market), that won't work. RBI will want to keep inflation low, and hence will sell some bonds to the public (sterilizing deficit monetisation) to reduce money supply. 
• What about gold: Govt. will issue bonds, people will buy bonds and give their gold, the RBI will then buy the gold from govt. with newly printed money. So Centre's debt grows (like in debt option earlier), but this time it's not the RBI but households that will subscribe to the bonds.
• Why gold won't work: Indians' fascination with gold means such gold bond schemes will not work well. They won't move to bonds, from gold!
• What about RBI's forex: The truth is that for every dollar of forex shown by RBI on asset side, an equivalent rupee amount has been created on liability side. Why so? Because when RBI acquires foreign currency, it pays using Indian rupee. So additional currency cannot be printed against reserves. 
• Only way to use forex: By pledging them with third parties, the RBI can generate new resources. It's like people taking loan against property. But who will the RBI approach? And this is a serious step to take, last taken in the 1991 balance of payments crisis (47 Tonnes of gold given to Bank of England). Mortgaging like that would be a shame today.
• So what are the options: Only 3 - taxes, debt and asset sales. So it's clear that higher debt is the only way to go forward for funding the stimulus, as taxes and asset sales won't fetch much now.

Read more on - Polity | Economy | Schemes | S&T | Environment

Join UPSC Self Prep course | Online Course (PT Gurukul)  | Covid Special Course | Join PT courses

* Content sourced from free internet sources (publications, PIB site, international sites, etc.). Take your own subscriptions. Copyrights acknowledged.