OCTOBER 2020 ISSUE NO. 409 Demand-Inducing Stimulus as Covid-19 Response: A Case for Debt Monetisation RIA KASLIWAL ABSTRACT As India reels from the economic fallout of Covid-19 despite the announcement of a relief package, calls for a more refined and demand-inducing stimulus have emerged. However, the bleak state of the government’s coffers has left limited fiscal space to act. This brief explains the plausibility of financing a demand- inducing stimulus using debt monetisation as a one-time policy measure. Outlining the criticisms against such proposals and how these could be managed, the brief calls for a framework for monetising state deficit. It argues that debt monetisation is the most appropriate way forward, given the government’s limited options amidst the urgency of managing the pandemic and stabilising the economy. Attribution: Ria Kasliwal, “Demand-Inducing Stimulus as Covid-19 Response: A Case for Debt Monetisation,” ORF Issue Brief No. 409, October 2020, Observer Research Foundation. Observer Research Foundation (ORF) is a public policy think tank that aims to influence the formulation of policies for building a strong and prosperous India. ORF pursues these goals by providing informed analyses and in-depth research, and organising events that serve as platforms for stimulating and productive discussions. ISBN: © 2020 Observer Research Foundation. All rights reserved. No part of this publication may be reproduced, copied, archived, retained or transmitted through print, speech or electronic media without prior written approval from ORF. Demand-Inducing Stimulus as Covid-19 Response: A Case for Debt Monetisation INTRODUCTION space despite borrowing and aid.16 Such limited spending has led to many issues India’s growth rate is projected to be unaddressed,17 including in particular, the negative for the present fiscal year,1 amidst demand problem.18, 19 If the government a pandemic of a virus that has infected over was to decide to spend more for economic six million Indians so far.2 The nationwide recovery, the question is where the money lockdown, as a response to contain the spread would come from. of the virus, led to soaring unemployment, the abrupt halt of supply,3 and plummeting MONETARY POLICY INSTRUMENTS demand,4 making conditions worse for an already weak economy.5 While the supply The Reserve Bank of India (RBI) has taken shocks eased marginally as the lockdown steps to address the huge liquidity crunch: was lifted beginning in June,6 current it lowered the repo rate, used Targeted forecasts suggest continued weak demand Long-Term Repo Operations 2.0 (TLTRO), in the country.7 Analysts project that FY21 engaged in bigger and more targeted lending, could be a year of deep recession for India.8 imposed a moratorium on loan payments, This will likely reverse the considerable and extended those moratoriums.20 These progress that India has made in various measures are considered innovative for the development parameters including poverty RBI, as it acknowledged the devastating eradication,9 education,10,11 nutrition,12 and economic fallout of the Covid-19 pandemic women empowerment.13 The imperative and therefore the need to ensure a smooth is to quickly nurse the country back to flow of money to the public via the banking health, and such goal requires a huge fiscal system.21 The Atmanirbhar Bharat package stimulus. further emphasised on such measures to render relief. The INR 20-trillion Atmanirbhar Bharat stimulus package announced in May, However, easing lending conditions amounting to 10 percent of India’s GDP,14 and providing more loans, does not imply while welcome, focuses mostly on monetary provision of credit to the neediest. It is still policy tools which form only contingent up to the banks to lend out the money, and liabilities.a The actual fiscal cost to the to the firms and entities to want to borrow government was a little over one percent that money.22 of the GDP, and has had little effect on demand.15 The government could not afford Upon identifying that the massive Non- a bigger package owing to its limited fiscal Profit Assets (NPAs) sitting with banks a Contingent Liabilities are legal commitments that governments must make payments for only if certain events occur. Thus, their fiscal cost is valid only when they become due. 2 ORF ISSUE BRIEF No. 409 OCTOBER 2020 Demand-Inducing Stimulus as Covid-19 Response: A Case for Debt Monetisation could make them risk-averse to lending to through Pradhan Mantri Garib Kalyan smaller and more vulnerable companies, Yojna or PMGKY), these have been largely the RBI rolled out TLTRO 2.0 to ensure a inadequate.28 Thus, fiscal policy measures smoother and more targeted flow of credit need to be implemented in parallel to these sectors. However, out of the INR with monetary policy tools. Only when 250 billion offered in the TLTRO 2.0 auction, accompanied by a proportionate increase in the RBI received bids worth only INR 128.5 government expenditure will RBI’s efforts billion.23 Such subdued response from the fructify. banks indicated their lack of willingness to lend to NBFCs (Non-Banking Financial The question then is—Where is the Corporations) and MFIs (Micro Finance money? Institutions), in turn weakening the RBI’s efforts at pumping liquidity to help these BORROWING FOR STIMULUS vulnerable sectors.24 A crisis the degree of the one presently Another reason for the slow provision of facing India, requires an effective stimulus credit is the poor credit demand scenario in package. From past experience, borrowing the country.25 Despite recent revival, loan from the market would have been enough growth has been sluggish at just 5.5 percent for the government to finance such a year-on-year, while deposits are soaring package. At present, however, there are at 10-11 percent y-o-y.26 This is explained various concerns over domestic borrowing. partly by the banks’ aversion to high levels of lending exposure, and also by the Even before the current crisis, household slowdown in enterprise (especially in the financial savings in India were already MSME sector) due to inadequate demand.27 significantly low and faltering further, with data indicating that savings of domestic This suggests that while it would be householdsb were barely enough to fund the crucial to offer the possibility of “easy” government’s existing borrowing needs.29 money to revamp the economy, it can only Furthermore, households and firms, too, work when India simultaneously solves need to borrow in the present circumstances the problem of inadequate demand. Solely to tide through the difficult times. The many depending on monetary policy would not be takers of the falling household savings imply enough; what is required is a combination that even if the government would want to of fiscal and monetary policy tools. While borrow domestically, the funding available fiscal steps have been taken (mostly would be insufficient. b Government borrowing is not from the entire stock of savings, but from the household financial savings, because only the household segment is a net saver, and all other segments are net borrowers. ORF ISSUE BRIEF No. 409 OCTOBER 2020 3 Demand-Inducing Stimulus as Covid-19 Response: A Case for Debt Monetisation Figure 1: Gross Domestic Savings Rate 32.4 31.1 31.3 30.1 2016-17 2017-18 2018-19 2019-20 Gross Domestic Savings Rate Fiscal Year Source: CEIC Data Furthermore, the ability of the revenue has been estimated at INR 2.35 government to pay back on time is also a trillion.32 concern, given falling revenues across the country. The revenue receipts for the Union With the government recording low government for fiscal year 2019-20 was revenues, creditors have become wary estimated at INR 19.63 trillion, although and risk-averse over the possibility of it was later revised to INR 18.50 trillion. government defaulting on loans. Such high The provisional estimates from RBI’s latest risk to lend, coupled with the inadequate figures is at a mere INR 16.82 trillion.30 supply of funds to borrow domestically, led to steep market interest rates. When Kerala, To be sure, the pre-Covid economy for example, borrowed for its fiscal package was already showing signs of weakness of INR 200 billion in early April, it faced and recording lower revenues. With the interest rates as high as nine percent.33 imposition of the prolonged, nationwide lockdown and the consequent slowdown With RBI’s intervention, the yield of economic activity, the revenues further has fallen significantly, and market dropped. Indeed, data from Trading interest rates have started to decline Economics and the Comptroller and Auditor to a little over six percent. However, General’s office (CAG) show that the Union sovereign bonds remained continually government recorded revenues of only INR unsold in RBI auctions,34 showing that 275.5 billion during the month of April its efforts to control yields has led to the 2020.31 Furthermore, the shortfall in GST market preferring corporate bonds over 4 ORF ISSUE BRIEF No. 409 OCTOBER 2020 Demand-Inducing Stimulus as Covid-19 Response: A Case for Debt Monetisation government bonds—a behaviour that is debt-to-GDP ratios.c If in such a scenario, not normally observed.35 If government India undertakes additional external debt borrowings continue to expand, there is at high interest rates,d servicing such debt every reason to suppose that yields will go becomes extremely costly and could raise up once again. questions over India’s ability to sustain its debt. This could, as Fitch Ratings suggests, External Borrowing further strain India’s sovereign ratings.39 While at present, India has enough foreign Reliance on external debt is a possibility, exchange to service its external borrowing but should be limited to a small proportion liabilities, the situation might change with a of the GDP.