Why in the news: Due to nationwide lockdown, economic activities have been halted. Almost all the sectors are demanding a bailout package. Since the economy has stalled and the government will not be getting its revenues, fiscal deficit is expected to shoot up to around 15% of GDP (Centre and States). Government can borrow money from market to finance the deficit, but there isn’t enough money in the market for the government to borrow. In this backdrop, RBI’s former governor, C. Rangarajan has advocated ‘Direct Monetisation of the deficit.’
Direct Monetisation of the deficit: This is a system where the government deals with the RBI directly — bypassing the financial system — and asks it to print new currency in return for new bonds that the government gives to the RBI. In this system, RBI directly buys bonds from the government.
Prohibited through FRBM: Until 1997, the RBI “automatically” monetised the government’s deficit. But under the Fiscal Responsibility and Budget Management (FRMB) Act, RBI had stopped the practice of direct monetization in 1997. The rationale was that central governments could fall prey to “print and spend” without any scruples with a central bank monetizing the borrowings. This would flare up inflation in a supply-constrained economy like India. (Indian Express and The Mint)
