How to pay for the stimulus

By, Pulapre Balakrishnan is a Professor of Economics, Ashoka University, Sonipat

Introduction

• Greater public spending will increase the fiscal deficit and this expansion has to be financed.
• Theoretically, it can be financed by higher taxes but it cannot be the case when the economy is in recession.

Debt vs. money financing

So, what are the options?

• They are: issuing debt to the public, and borrowing from the Reserve Bank of India (RBI), termed ‘money financing’ as it increases the money supply.
• Dr Manmohan Singh suggests plumping for increased debt.
• While they do not rule out court money financing, they suggest that it may be imprudent to do so.
• Instead, they recommend borrowing from the World Bank and the International Monetary Fund (IMF). However, it is not clear that this is a superior strategy.

Is borrowing a solution?

• The media has recently reported some economists responding to the suggestion of money financing with the Friedman-Esque quip “there ain’t no free lunch”.
• But it may be mentioned that there is no free lunch in the case of debt financing either.
• Not only have the money be repaid, but they will also have to be paid back in hard currency.
• This would involve India having to earn hard currency by stepping up exports.
• If a stimulus of approximately 10% of the GDP is envisaged, with exports at 25% of the GDP, it would imply stepping up exports by close to 50%.
• This would be a herculean task under present circumstances. Indian exports have been faring poorly since 2014. Since then, there have been multiple shocks to global output and trade.
• Three more issues are relevant when considering borrowing from the World Bank and the IMF.

1. First, there is the issue of conditionalities. There is no reason to oppose conditionalities on principle but it is not obvious what conditionalities will come along with the loan.
2. Second, a loan is bound to take some time to be negotiated, taxing the energies of a government that ought to be engaged in the day-to-day battle with COVID-19.
3. Third, external debt is truly national which, arguably, government bonds held by the country’s private sector are not.

A taboo subject

• When money financing is proposed, it elicits a negative response from some quarters with something akin to a taboo being invoked against the idea.
• But invoking taboo is not serious economics which would require that a good reason be given for opposing the use of money financing to expand public spending at present.
• Dr Singh speaks of “high intangible and institutional costs” associated with it but does not expand on this.
• The standard economic argument against money financing is that it is inflationary.
• However, whether a fiscal expansion is inflationary or not is related more to the state of the economy than the medium of its financing.
• When resources are unemployed, the output may be expected to expand without inflation.
• As COVID-19 has shocked output downwards, unemployed resources must now exist. There is no reasoned case for denying ourselves the option of money financing to take us back to pre-COVID-19 levels of output and employment.