Context:

• The economic impact of COVID-19 has resulted in unanimity among economists that the global economy will experience one of its worst years in history. 
• India is no exception and it is clear that, for the first time in many decades, India’s economy will contract significantly.
• This necessitates greater public spending as an essential condition to revive the economy.

Ways to finance

• Greater public spending will increase the fiscal deficit and this expansion has to be financed. This financing can be done by external borrowings or monetisation of deficit.

External Debt vs. Monetisation of Deficit

External Debt?

• External debt is the portion of a country’s debt that is borrowed from foreign lenders, including commercial banks, governments, or international financial institutions like the World Bank and the International Monetary Fund (IMF).

Challenges associated with borrowing

1. Stepping up exports- herculean task

• • The borrowed money to be paid back in hard currency would involve India having to earn hard currency by stepping up exports. 
  • This would be a herculean task for India at present circumstances and also having been subjected to multiple shocks to global output and trade since 2014.
• Hard currency refers to money that is issued by a nation that is seen as politically and economically stable. Hard currencies are widely accepted around the world as a form of payment for goods and services and may be preferred over the domestic currency.

2. Issue of conditionalities

• It is not obvious what conditionalities will come along with the loan. 

3. Takes time

• A loan is bound to take some time to be negotiated, taxing the energies of a government that ought to be engaged in the day to day battle with COVID-19. 

Monetisation of Deficit

• Monetised deficit is the monetary support the Reserve Bank of India (RBI) extended to the Centre as part of the government’s borrowing programme. 
• In other words, the term refers to the purchase of government bonds by the central bank from the primary market or printing currency notes to finance the spending needs of the government.

Challenges associated with monetising deficit

• High intangible and institutional costs associated with it.
• High money supply may result in inflation. 

Money financing- an optimal solution

• Whether a fiscal expansion is inflationary or not is related more to the state of the economy than the medium of its financing. 
• Also, as COVID-19 has shocked output downwards, unemployed resources must now exist. 
• When resources are unemployed, output may be expected to expand without inflation. 
• Thus the option of money financing can take us back to pre-COVID-19 levels of output and employment.

References:

1. https://www.investopedia.com/terms/e/external-debt.asp
2. https://www.thehindu.com/opinion/op-ed/how-to-pay-for-the-stimulus/article32279610.ece
3. https://economictimes.indiatimes.com/markets/stocks/news/deficit-monetisation-is-it-really-as-simple-as-rbi-printing-more-money/articleshow/75968757.cms