Former central banker Viral Acharya warned against the Reserve Bank of India monetizing the government’s budget deficit, citing risks to inflation and external sector stability.
“Adopting this approach is also deeply flawed,” according to excerpts from Acharya’s soon-to-be-released book: ‘Quest for Restoring Financial Stability in India.’ It “would mean regressing to errors of the 1970s and 1980s.”
Acharya, whoresigned last year after raising concerns about the central bank’s independence and the health of state-run lenders, was referring to experience of the past when the RBI’s monetization of government debt led to a spike in consumer prices and a balance of payments crisis. The RBI’s mandate is to keep inflation within a band of 2%-6%.
While India’s Fiscal Responsibility and and Budget Management Act prevents the central bank from buying bonds directly from the government in the primary market, calls have been growing to get the RBI to directly buy the sovereign’s debt using a provision in the law that allows such an action in the event of the country facing a national calamity or a severe slowdown.
With the coronavirus outbreak presenting that opportunity, Acharya said this could lead to financial repression in the economy. It could also fan India’s twin deficits — fiscal and current-account gaps — leading to a loss in investor confidence.
“Such risk has materialized unexpectedly at least once a decade over the past 30 years with several minor hiccups in between. History tells us that we ignore this risk at our own peril,” he wrote.
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