A Comment on Rajaraman's Response :

A Comment on Rajaraman

DISCUSSION

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 n@hotmail.com) currently heads the Monetary Research Project, ICRA, and is based in Kolkata.

Notes

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

References

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).