Is monetization the only solution right now?
In my opinion, interest rates will rise and a large fiscal deficit will crowd out private borrowing if it is not monetized by the government. But it will benefit the economy only in the initial stages. It sounds easy to implement—money is needed, so print it and the rates will not rise. But then, if monetization is the only panacea, then why does the government not wipe out the entire fiscal deficit by printing more money? That’s what Germany did in the 1940s and it had to deal with soaring inflation. There is no free lunch. All monetization does is prolong the pain. In the initial stages of inflation, there is only gain. In the later stages, there is only pain. Printing money initially comes at no cost, but will result in higher taxes for the next generation.
Ultimately, the monetized money has to go someplace. It will find its way to the sectors where the return on capital is very high. It will fuel a stock market rally or create a bubble in the real estate market. The government can decide to print more money, but can’t decide on the flow of that money. Money has a life of its own and creates one too.
What is the solution then?
All I can say is that we have pushed ourselves into a corner. If we do not resort to this sort of deficit financing, there would be a social revolution in this country.
The government will print more money. It will go towards drought relief. It will be given for the higher salaries recommended by the Sixth Pay Commission. If the government stops providing NREGS (national rural employment guarantee schemes) money, it will force the unemployed to migrate to cities. At least you are providing them with work for 100 days. When people are meaningfully employed, there will not be a social revolution. It’s when people lose their jobs, or are unemployed, that unrest sets in.
But we are not creating capital. Create infrastructure. Link the faraway village which is producing for the city. These farmers deal with perishable commodities, so create infrastructure for them. When the times are good, the government should have built up enough to combat situations such as the one we are facing today. Over the last four years, we have not had fiscal prudence. The government gave more importance to building revenue expenditure than capital expenditure.
Where do you see inflation heading?
I see inflation—in terms of WPI (Wholesale Price Index)—touching 8-10% by March. This is way beyond the Reserve Bank of India’s (RBI’s) target of 4%. Inflation is on the rise. The prices of soft and hard commodities are going up. Some of this rise could be attributed to speculative activity. But when you put too much money into the economy, you will have to deal with inflation.
With RBI supporting the government’s borrowing programme, won’t there be a pressure on interest rates?
Definitely. This year, the banking system will have Rs7 trillion of fixed deposits. Now, the government is going to corner Rs5 trillion. That leaves barely anything for the private sector. Sure, the latter can borrow from abroad, but the rates are higher. This private demand for capital is going to result in interest rates rising. Let’s say there are some power companies borrowing 10-year money. We have a fixed amount of money available—remember, this country is short of capital. And from what is available, the government is taking a chunk. If it takes much more, the interest rates will shoot through the roof.
That is why the government is printing money. I do see the cash reserve ratio (CRR) rate rising in the next five months. Either interest rates will rise or the currency will take a beating. The government will have to do a fine balancing act between keeping the currency stable and the interest rate low. You get foreign money coming in because they believe that your currency is stable or will appreciate. But when currency begins to depreciate, this money will make an exit. Then what would be the incentive? Why would they (foreign companies) come to India and buy debt if the currency is going to depreciate?
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