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Foreign exchange & precious metals
More news. Bilanz Magazine Interview with Dr. Arthur Vayloyan 18th December, Among the suggestions are the printing of currency, and using foreign exchange reserves or household gold. To examine these ideas, we first need to familiarize ourselves with a typical central bank balance sheet.
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The liabilities side of it comprises the currency in circulation, commercial bank reserves money kept by lenders with it and government reserves State balances kept with it. The asset side has forex reserves, government securities and gold.
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Against this background, let us address the elephant in the room—printing currency to finance the stimulus bill. These assets could be government securities, forex reserves or gold. Thus, one way for the government to finance its expenditure would be to issue government bonds and ask RBI to print currency with which to subscribe to such bonds.
This is known as deficit monetization.
Until , deficit monetization was automatic, granting the Centre much leeway in managing its finances. That year, the government and RBI struck an agreement to stop automatic monetization. As a result, the government was compelled to issue bonds in the debt market, and if RBI wanted to lend the government a helping hand, it would buy bonds issued by it from the debt market but not directly from it. Even if the government and RBI were to sidestep the compact as an emergency measure, it is important to note that for the central bank to print money, the government would have to issue bonds to it, which will increase government debt.
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If the intention behind issuing bonds to RBI is to prevent an increase in government debt held by the public, it is not clear that such an objective can be met. This is because to keep inflation in check, RBI may have to sterilize deficit monetization by selling some of its government bonds to the public and thus reducing money supply. Another proposal doing the rounds to finance the stimulus bill is for monetizing the gold held by households in India.
This would first involve the government buying gold from households in exchange for its bonds. Then, the accumulated gold would be bought by RBI from the government with newly printed currency.
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- Opinion | Gold and forex reserves cannot finance India’s stimulus.
The difference between this proposal and the one discussed earlier is that instead of creating new money to acquire government bonds, RBI would be doing the same to acquire gold. Like in the case of printing currency by issuing bonds to RBI, this too involves the Centre taking on additional debt. For purists, printing currency using gold might provide some comfort.
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However, any proposal that involves households swapping their gold for government bonds cannot be taken seriously. Gold monetization schemes in the past have yielded only mild success. Indians have a strong fascination for the yellow metal. To expect them to shift from investing in gold to dabbling in government bonds is a fantasy.
A big fallacy of this proposal is that it ignores the fact that against every dollar of forex reserves shown by RBI on the asset side, an equivalent rupee amount has already been created on the liability side. This is because whenever RBI acquires foreign currency, it pays for it using the Indian rupee.
Thus, no additional currency can be printed against such already-acquired reserves.