A combination of factors ranging from large fiscal deficit to suppressed inflation and debt dynamics have ensured that the fiscal dominance of the monetary policy continues to persist.
Making this observation, the “Report on Currency and Finance, 2011-12 on fiscal-monetary co-ordination’’ released by the Reserve Bank of India (RBI) pointed to new challenges that had emerged in the recent past for its monetary policy initiatives.
The report said large market borrowings to fund high fiscal deficits had, at times, led to de facto monetisation of the deficit. Added to this was the inflationary potential of such a large deficit. The pro-cyclicality of government spending and deficit-debt dynamics had only put extra pressures on the monetary policy, the report said.
The Indian experience, according to the report, suggested that fiscal rules, though necessary, weren’t sufficient to optimise the outcomes of the fiscal-monetary co-ordination. In this context, the report felt that the rules for fiscal regime could be improved by focusing on structural deficit, adopting broader definition of both deficit and debt to cover quasi-fiscal activities and removing ambiguity on exceptions by including expenditure rules to deficit rules.
“The persistence of very large borrowings by the governments has significant macro-economic, monetary and financial stability implications,’’ it said. In these areas, the central bank “has an undeniably important, if not unique, role to play,’’ the report added.
In this context, it pointed out that the debt management of all the State governments had cast an added and distinct dimension to the issue. Hence, the report felt, “there is a need to review the content and pace of the proposed shift of the debt management function from the central bank to the Government.”
The report felt the institutional arrangements for government debt management in India over the medium-term would require the continued involvement of the central bank coupled with more intensive co-ordination with the government.