Deficit monetisation must be for the right reasons

In his post budget press briefing the Finance Minister said in no uncertain terms that the approach to managing public finance this year will be very different from previous years. Availability of finance used to constrain public spending in the past. In FY21, it will be the opposite – the government will spend whatever needs to be spent and worry about financing later. This essentially means that the Bangladesh Bank (BB) will have to pick up the tab if there is no other financial institution to honour the cheques issued by the government.

In other words, the government will resort to the proverbial "money printing machine" to finance the gap in resource mobilisation. It literally will not have to print money but borrowing directly from the BB essentially has the same effect.

Given the unique health and economic challenges created by the pandemic, the recourse to the lender of the last resort is not an anathema like it used to be in the past. A global pandemic has a way of bending conventional wisdom. Governments around the world had to implement the social distancing that we are all adjusting to. Workers and businesses of all sizes – big, medium and small irrespective of the sectors – are engaged in need monetary relief.

Workers are without jobs, firms are failing, banks are accumulating non-performing loans and the government is facing severe revenue crunch. The scale of disruption, with or without lockdown, is massive. The unemployment rate is shooting up, whether we measure it or not, and poverty is rising no matter how we assess it. Urban unemployment is most likely to have reached an all-time high. The hard-earned rise in female participation in formal sector work is at risk of being reversed.

Thanks to the indecisiveness of the owners, a significant proportion of those employed in the garment factories joined involuntary walkathons to their respective workplaces and then back home. Job losses, non-payment of dues by the employers, lack of access to food, or just the confidence to face the pandemic with resources available at their village homes induced millions of urban households to migrate back to their rural roots. They need support from the society in general and the government in particular.

The government has proposed an expansionary budget like all other governments in the world today. The government's budget deficit in FY21 is destined to exceed the 6 percent target by a large margin as revenues plunge. There is likely to be a shortfall in the realisation of the external financing target as well. The banking system is stressed. There are limits to how much it will be able to accommodate, given abysmally low deposit growth and poor loan recovery rates.

Monetisation of deficit is inevitable. The best way to do it is through the front door. The BB cannot just ask the authorised dealers (scheduled banks) to buy on its behalf through a practice known as "devolvement". Whatever is raised must be deployed in an expenditure programme that has health and social protection at the centre. This will create confidence and protect the poor and the vulnerable. Subsidised credit to large enterprises should be given only to keep as many people on their payroll as they had at the end of February.

With a limited fiscal response, the BB has taken the lead in providing virus relief so far. It cut the policy rate, reduced the cash reserve ratio, expanded the repo facility, imposed a moratorium on loan repayments and interest payments, relaxed regulations on loan classification, expanded existing refinancing facilities and opened new ones. Its refinancing schemes are the equivalent of private enterprise bond purchases by the central banks in developed markets as part of their Quantitative Easing (QE) programmes. A key difference of course is that the BB does not take on the default risk. This rests solely on the shoulders of the financial intermediaries.

The BB may directly buy treasury bills and bonds. The BB has bought Tk303.21 billion Bangladesh Government Treasury Bonds, provided Tk45.8 billion Ways & Means Advance, and Tk73.3 billion in overdraft while liquidating about Tk43.8 billion of previously held government debt to the BB from July 1, 2019 to May 13, 2020. The monetisation of the government's debt flows during this period accounted for 63.7 percent of the new debt issued by the government to finance the growing budget deficit. The BB also resorted to purchase of debt from the repo market which stood at Tk75.3 billion in the week ending June 6.

In the post-pandemic world, the call for deficit monetisation has gained traction in both developed and developing countries alike. The reason is simple. The repercussions of not spending enough to support the poor and vulnerable and keep enterprises afloat may be beyond repair. Raghuram Rajan, former governor of the Reserve Bank of India (RBI), advocated deficit monetisation in a "measured" manner to protect the economy through cash handouts to the poor, shouldering part of the wage burdens of the enterprises and providing temporary relief to the taxpayers.

Rajan rightly cautions that "monetisation will neither be a game changer nor a catastrophe". A large borrowing within short time cannot be managed without monetization. But, unlike in rich countries, this option for governments in countries like Bangladesh is limited by the non-convertibility of their currency internationally. The fundamental reality facing the government is that it can neither borrow the money it needs from international commercial markets nor have the BB "print" more and more taka without risking a run on the taka and shaking confidence. Among the major risks is that the government may not spend wisely. Another risk is that a bottomless government wallet could lead to spiralling inflation.

In extraordinary situations like this pandemic, money is the way out. Yet there never is a free lunch, pandemic or no pandemic. The worry is not about BB buying government bonds, the worry is about buying too much of them and for the wrong reasons.

Monetisation of deficit provides a temporary bunker for public debt where it cannot be held forever. As Duvvuri Subbarao, another former governor of the RBI, has recommended, the government should commit to a predetermined amount of additional borrowing and plan to reverse the action after the crisis is over.