Direct monetization

Subject: Economy

Context:

A report by the State Bank of India has recommended direct monetisation as a possible way of funding the Centre’s deficit at lower rates, without increasing inflation and affecting debt sustainability.

Concept:

• Monetising fiscal deficit means the RBI purchases government debt directly rather than the government borrowing from the markets by selling bonds.
• In turn, the central bank prints more currency to finance this debt.
• 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 lieu of printing this cash, which is a liability for the RBI , it gets government bonds, which are an asset for the RBI since such bonds carry the government’s promise to pay back the designated sum at a specified date.
• Until 1997, the government used to sell securities — ad hoc Treasury-Bills — directly to the RBI, and not to financial market participants.
• This allowed the government to technically print equivalent amounts of currency to meet its budget deficit. This practice was stopped over its inflationary impact and in favour of fiscal prudence.