What constitutes monetisation of Debt ?

Monetisation of debt is a difficult concept to comprehend, as it is not clearly defined. It can occur through several practices that may be transparent, translucent, opaque or hidden. For long, monetisation of debt was understood as “converting government debt to money” or “the central bank’s purchase of government bonds when they are issued”. Either definition has its problems. Typically, the government can finance its deficits by printing money or issuing debt. The former directly attenuates monetary control. In the modern world, with central banks in charge of controlling the aggregate money supply, governments typically finance their deficits by issuing government bonds. They can either be purchased by the public from the existing supply of money or by central banks by increasing the monetary base, and hence the money supply. The key question is whether any purchase of government securities by the central bank would tantamount to monetisation of debt.

Central banks, conducting monetary policy through open market operations, purchase (or sell) securities to infuse (or absorb) liquidity. They do so to adjust the monetary base and/or the interest rates in line with their targets. These operations are often conducted on a day-to-day basis, sometimes more than once a day. So, if mere purchase of government securities by the central bank is seen as monetisation, almost all central banks do it almost all the time. So, does monetisation reflect the central bank’s purchase of government securities in primary but not secondary markets? If the central banks go on infusing liquidity to support the banking sector’s purchases of government bonds even while not subscribing to its primary issuances, the net result would be the monetisation of debt. Central bank purchases of government securities expand the monetary base, but the finer distinction for monetisation is whether such purchases are to primarily support government debt operations.

Further, in practice, it is still hard to make a black-and-white distinction between what portion of the central bank’s purchases of government securities is for the purpose of the conduct of monetary policy and what proportion is to support government’s borrowings. For example, in 2012-13 the size of the government’s net market borrowing programme (dated securities) increased nearly 9.7 times in eight years to INR 4.9 trillion. During this period, the Reserve Bank conducted large net open market purchases that included  INR 945 billion in 2008-09, INR 755 billion in 2009-10, INR 672 billion in 2010-11 and INR 1.3 trillion each in 2011-12 and 2012-13. While in principle the Reserve Bank uses open market operations to impact liquidity and monetary conditions, in practice it is not easy to decipher what part of the open market operations were undertaken purely on these very considerations and what part might have been influenced by the consideration that large government borrowing may be market disruptive. During 2008- 09, OMOs were in sync with monetary policy easing undertaken in that year on the back of the global financial crisis. However, between March 2010 and October 2011 monetary policy was clearly in a tightening mode. Whether OMO purchases in this period attenuated monetary policy efficacy can definitely be a matter of debate. Furthermore, as illustrated in our earlier article Question : Who lends money to Indian government ? RBI’s share amongst investors has increased by almost ten percentage points since 2007. This can force one to argue that debt monetisation in some form and shape has already been happening for the past decade.

The above article has taken references and extracts from “RBI’s REPORT ON CURRENCY AND FINANCE 2009-12 FISCAL-MONETARY CO-ORDINATION

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