Fenil's Library

With the money-printing press on its side, the government can keep borrowing money to spend more than it earns

Vivek Kaul. Mumbai

“With the monsoons arriving, the wet look among women is back, I guess,” I said.

“Don’t know about the wet look, but I had to wade through knee-deep water to get back home today. And Pranabda’s Budget was an exceptionally dry Budget. ‘Monsoon main sukha Budget,’ went the headline in a Hindi newspaper,” she replied.

“Yeah and more than that, the fiscal deficit numbers are getting scarier,” I elucidated.

“There you go again, trying to show off that you understand economics.”

“Why not? As the film heroines say “flaunt it, if you have it.””

“But why is the scenario scary?” she asked.

“Fiscal deficit, as you’d know, is the difference between what the government earns and what it spends. Typically, most governments spend more than what they earn, and hence the deficit. Now let us take a look at the Indian deficit numbers. In the financial year 2007-08 (i.e. between April 1, 2007 and March 31, 2008) the government spent Rs 1,26,912 crore more than what it earned. For the financial year 2009-10 (i.e. between April 1, 2009 and March 31, 2010), the government plans to spend a whopping Rs 4,00,996 crore more than what it earns.”

“Or 6.8% of the gross domestic product (GDP)?” she interrupted.

“Yeah. The GDP of India is assumed to be at Rs 58,56,569 crore for 2009-10. The projected fiscal deficit expressed as a percentage of this stands at 6.85% to be very precise. But this does not give the correct picture.”

“Then what gives the correct picture?”

“The fiscal deficit of India in 2007-08 stood at Rs 1,26,912 crore. In comparison to that, the projected fiscal deficit of Rs 4,00,996 crore for the financial year 2009-10 is 216% more. What that means in simple English is that the income of the government of India has been more or less constant over the last few years, though its expenditure has been going up. In 2007-08 the income of the government of India stood at Rs 5,85,759 crore. For the year 2009-10 the income has been projected to be Rs 6,19,842 crore. This means that the income has gone up by 5.8%. The expenditure for 2007-08 stood at Rs 7,12,671 crore whereas the projected expenditure for 2009-10 stands at Rs 10,20,838 crore or a whopping 43.2% more. The trouble with expressing fiscal deficit as a percentage of GDP is that we never really understand the enormity of a situation. In 2007-08, the government earned Rs 5,85,759 crore and it spent Rs 7,12,671 crore, which means it spent Rs 1,26,912 crore or 21.7% more than what it earned. In 2009-10, it is projected to earn Rs 6,19,842 crore and spend Rs 10,20,838 crore, which means that it plans to spend 64.7% more than what it earns. Now that better expresses the enormity of the situation,” I explained.

“But where will the difference come from?”

“Let me ask you a question. When in a given month your expenditure is more than your income, what do you do?”

“I dip into my savings,” she replied.

“What if you do not have any savings?” I questioned again.

“Oh then I use my credit card. I have one too many of them anyway.”

“Yeah you use your credit card, which means you borrow. Similarly when the government spends more than what it earns, it borrows by issuing financial securities known as treasury bills and bonds or government securities. So in the year 2007-08 the government borrowed Rs 1,26,912 crore to service its deficit. And in the year 2009-10, it will have to borrow Rs 4,00,996 crore to fund its deficit.”

“Hmmm. So what is the problem with that?”

“Hold on, babes. Let me complete. When you have to repay the debt you have taken on your credit card, what do you do? You either spend less in the months to come or increase your income.”

“Yeah, any logical individual would do that.”

“But you must remember that the government cannot suddenly increase its income to pay off its debt, neither can it cut down on its expenditure. So what does it do to pay off its debt or even servicing the interest on that debt? It takes the third way out.”

“The third way?”

“Yeah. Let us take your case. What if you did not have enough money to repay your credit card bill? What would you do? You would try and use your second credit card to pay off the amount due on your first credit card. And when things get difficult on your second credit card, you would use your third credit card to pay off the dues on the second card. And so the story would go on, till you run out of cards.”

“Yeah. Of course. But what has my ability to repay my credit card bills got to do with the government of India?” she asked.

“Like you, the government takes on more debt to repay its earlier debt as well as to repay existing loans. Let me explain. In the year 2007-2008, the interest payment of the existing debt of government of India stood at Rs 1,71,030 crore whereas it borrowed Rs 1,26,912 crore to fund its deficit. What this means in simple English is that some portion of the interest to be repaid (Rs 1,71,030 crore - Rs 126,912 crore = Rs 44,118 crore) was being paid out of actual earnings and not just by borrowing more. Now for 2009-2010, the interest payments of the government stand at Rs 2,25,511 crore whereas the projected fiscal deficit stands at Rs 4,00,996 crore. What this means is that nearly 56.2% of borrowed money is just being used to service past debt. The government does not earn enough money to pay back the interest on its debt. So what does it do? It takes on more debt to pay interest on its existing loans. A perfect Ponzi scheme! The word Ponzi comes from Charles Ponzi, an American-Italian, who in the year 1919, promised to double investors money in 45 days. What he essentially did was to create an illusion of a successful business by using the money brought in by new investors to pay off the old investors. Essentially, the capital of the scheme was used to pay interest as well as repay the money invested. This is what most governments which spend more than what they earn have been doing over the years, including the government of India.”

“So what you are effectively saying is that the government never runs out of credit cards?”

“Exactly.”

“But tell me something, don’t investors who buy bonds issued by the government to funds its fiscal deficit know this?”

“Of course they do. But governments have the right to print money which you and I don’t. So worst comes to worst, they can always print money to repay interest as well as principal. As the fiscal deficit increases the temptation for the government to print money and repay debt as well as interest on that debt, increases. In fact of the fiscal deficit of Rs 4,00,996 crore projected for 2009-10, the Reserve Bank of India will pick up half of the bonds being issued to fund the deficit. What this means in simple English is that big time money printing to fund the deficit has already started. Financial history tells us very clearly that high fiscal deficits have never been such a great idea. It ultimately leads to governments printing money big time, increased inflation and in some cases even the collapse of a currency. Pranabda should keep that in mind.”