The government’s financial situation has been going into a crisis situation over the last few years. With this the fiscal deficit had gone way over the permissible limit. Fiscal deficit is the total amount of borrowings to bridge the gap between its spending and earnings or the revenue.
The impact of COVID-19 on the economy, which was already slowing down rapidly over the past couple of years, has completely stalled. Most estimates suggest that India’s GDP (gross domestic product) will barely grow in the current financial year — that is, if it does not contract as is likely to be the case in most major economies of the world.
The cycle of money – who does what?
With a nationwide lockdown, incomes have fallen and so have consumption levels. In other words, the demand for goods and services in the economy has gone down. Under the present circumstances, most important source of government income, i.e taxes etc. have dried up. RBI has already brought in some liquidity into the markets by lending to the government against government bonds. So in the present circumstances combined revenue collections of centre and state governments are running greater than expenditure there by increasing the fiscal deficit to over 15% of the GDP, where as a deficit of 6% is the permissible limit.
To boost the demands, there needs to be more money in the hands of the people. Therefore the government is forced to borrow money. This borrowing is done from the markets or from peoples’ savings. Data shows that savings of house hold incomes have been faltering. Investments by foreign investors have also been shifted to safer economies like the USA. Therefore any more borrowing from the markets will only push up the interest rates.
Direct and Indirect monetising of the deficit.
Direct monetising means that the government asks the RBI to print more currency for alleviating the pressing needs i.e. to feed the poor, immediate needs of health care and direct cash transfers, financial support for kick starting industry etc. This is done against purchase of bonds from the government, which the government would return at a later date. On the contrary in Indirect Monetising the RBI does the borrowing from ‘Open Marketing Operations’. Till about 1997, RBI used to automatically monetise the government deficits. However, the major point against it is that even though it gets more money in circulation, it feeds inflation, which can spin out of control. At present governments’ borrowing stands at about 70% of the GDP and most economists believe that in developing countries like India, this borrowing should not be allowed to go beyond 80-90% of the GDP. Therefore this should be a carefully worked out policy of financial prudence to be followed by the government within a stipulated time frame.