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A Comment on Rajaraman's Response

A Comment on Rajaraman


A Comment on Rajaraman’s Response

Mihir Rakshit

Iam grateful to Indira Rajaraman for financial institutions fare in the medium
going through my paper on the THFC run; (b) whether the deficit is fi nanced
and responding to it at some length. through dollar-denominated debt, dome-
My rejoinder is as below and the num stic borrowing or seignorage; (c) the pre
bered points are as in the response: vailing degree of slack in the economy;
and (d) additional GDP generated over
(1&2) Fiscal Adjustment Programme time due to enhanced lending by banks to
and GDP Growth: With an initial excess credit-constrained enterprises.
capacity, extremely weak (domestic) pri
vate demand for investment and (non- (6) Human Capital Formation: Is cutting
agricultural) consumption goods and down expenditure on education a potent
the anaemic pace of recovery of advan way of promoting efficiency of investment
ced countries,1 the FAP and projected in human resources? How is one to factor
growth path over the fi ve-year period this in while setting expenditure targets?
have to be based on the short-term con- Would treating expenses on public works
sideration of avoiding the output gap and projects as revenue expenditure be justifi
the medium-term need of bridging the able on the same ground?
economy’s infra structural-cum-human re
sources shortfall. The pertinent point to (8) Seignorage: The (quasi) fi scal costs
note here is that even wasteful govern of negative seignorage during the pre
ment expenditure for closing the gap is crisis period was minuscule compared
welfare- and GDP-enhancing in view of with the huge loss the economy suffered in
the zero oppor tunity cost of resources terms of the unrealised investment/con
used (Rakshit 2005, 2011). See also com sumption potential. With an output gap,
ments under 8 below. the least-cost/least-distortionary mode of
financing enhanced government expen
(3) Crowding Out: By how much and in diture is seignorage. At the non-accelerating
which areas should public capital expend inflation rate of unemployment (NAIRU),
iture be scaled down on considerations of however, the optimum seignorage de
the currently prevailing incidence of cor pends (proximately) on the growth rate
ruption? The cost-benefit calculus used and people’s demand for real balan ces
by the THFC in this context while fi xing (Rakshit 2005); capital inflows to the
the expenditure targets is not clear. extent they promote the (NAIRU) growth
rate raise rather than lower the scope for
(4) Disinvestment: Financing government seignorage. Holding forex reserves in
capital expenditure of (say) Rs 1,000 crore excess of what is required for smooth
through disinvestment2 whose present value ening the volatility of the exchange rate
(of future earnings foregone), discounted due to random shocks or speculative be
at the government’s (not private inves haviour, does not make economic sense:
tors’) borrowing costs, exceeds Rs 1,000 capital inflows are required primarily for
crore is suboptimal and reduces the augmenting investment when there is
attractiveness of sovereign debt to ration no output gap, not when resources are
al investors (Rakshit 2005). underutilised (Rakshit 2003). The opti
mum policy package during the pre-crisis
(5) Financial Inclusion: Rational private period would have consisted of enhanced
investors would take into account the fact government investment and redistri
that the debt burden due to the defi cit butive expenditure, fi nanced through
spending depends crucially on (a) how the seignorage; imposition of taxes on FIIs
140 march 26, 2011

along with curbs on external commercial borrowings; and coordination of expansionary fiscal and monetary policies (Rakshit 2003, 2009). The fact that the RBI took recourse to large scale sale of government securities even while there was a substantial output gap attests to the glaring failure of macroeconomic policy coordination.

(10) Macro-stabilisation: Volatility of private investment, especially in an increasingly open economy, has very little to do with fiscal consolidation whose main outcome is (or is expected to be) promotion of average/trend growth in the medium and long run, not ironing out business cycles. Hence the need for a two-pronged fiscal management programme, as elaborated in Rakshit (2005, 2011).

Mihir Rakshit (proj_monfi currently heads the Monetary Research Project, ICRA, and is based in Kolkata.


1 Still accounting for the major part of world income. 2 Rather than market borrowing.


Rakshit, M (2003): “External Capital Flows and Foreign Exchange Reserves: Some Macroeconomic Implications and Policy Issues”, Money & Finance, Vol 2, Nos 13-14, April-September; reprinted in Mihir Rakshit (2009), Money and Finance in the Indian Economy (New Delhi: Oxford University Press).

  • (2005): “Budget Deficit: Sustainability, Solvency and Optimality” in A Bagchi (ed.), Readings in Public Finance (New Delhi: Oxford University Press).
  • (2009): “Using Forex Reserves for Infrastructural Investment”, Money and Finance in the Indian Economy (New Delhi: Oxford University Press).
  • (2011): “Budgetary Rules and Plan Financing: Revisiting the Fiscal Responsibility Act” in M Govinda Rao and Mihir Rakshit (ed.), Public Economics Theory and Policy: Essays in Honour of Amaresh Bagchi (New Delhi: Sage Publications).
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