Raghuram Govindarajan is an Indian economist and the Katherine Dusak Miller Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. Between 2003 and 2006 he was Chief Economist and Director of Research at the International Monetary Fund.

In a LinkedIn post, former RBI governor Raghuram Rajan, explained how the two paths work and why ‘monetisation’ is a good option in the short-term and withing reasonable limits.

“Direct RBI financing is sometimes loosely termed money printing and thought to be free”, but Rajan says this is “misleading”. The reason is because the government finances itself from RBI while RBI finances itself from the banks at the reverse repo rate of 3.75%.

 

“Direct RBI financing is sometimes loosely termed money printing and thought to be free”, but Rajan says this is “misleading”. The reason is because the government finances itself from RBI while RBI finances itself from the banks at the reverse repo rate of 3.75%.

This represents a loss to the government in two ways: first, a reduction in the annual dividend RBI pays the government. Second, banks get 3.75% instead of the 6% they could get by buying government bonds directly. And since the government owns 70% of the banking sector, its dividends from public sector banks also fall commensurately. Rajan points out that as normal times return, RBI will have to pay a higher rate on excess reserves, or sell its government bond holdings and extinguish excess reserves, else it will risk excessive credit expansion and inflation.

Rajan says that if the fiscal deficit and the growth in government debt is deemed unsustainable, “investors and rating agencies will take fright”. He thus calls for measures that ensure “we will go back to fiscal health over the medium term”.