Household family silver as sovereign collateral to rescue Covid-hit economy?

By Andy Mukherjee

A rare meeting of minds between India’s Left and Right on a point of economics should alarm those who belong to neither. The two sides are tossing out similar — and similarly absurd — ideas.

Before they make Prime Minister Narendra Modi’s government do something silly and harmful (such as the overnight ban on 86% of currency notes in 2016), both camps should acquaint themselves with rudiments of Modern Monetary Theory.


It postulates that inflation — and not debts or deficits — is the only real constraint on what a modern government not yoked to the gold standard can afford. Even for those who aren’t MMT cheerleaders, its basic contention is worth remembering: A money-printing sovereign that issues debt in its own currency can’t run out of funds the same way as a household or a firm.

Pro-labor academics, activists and social workers who think it’s morally justified to expropriate private property to support India’s pandemic-flattened economy should know that such extreme measures are unwarranted. The proposal from the fiscally conservative, pro-business side to use people’s gold as collateral to raise emergency public resources is also indefensible.

An extended lockdown, still-rising infections and an underwhelming fiscal response are causing the nation of 1.3 billion people to lurch toward self-defeating economic nationalism. In other ways, too, the crisis of lives and livelihoods is clouding rational thought. An otherwise well-meaning memorandum by a group of economists and trade unionists asked the government to treat all cash, property, bonds and real estate held by Indian citizens or in the country as national resources during the Covid-19 crisis. Amid trenchant criticism, the idea was quickly dropped.

But an equally bizarre proposal from the other end of the political spectrum, more closely aligned with the Modi government, is far from dead. An article in the Business Standard last month said that to print money to revive the economy, authorities are contemplating using gold held by citizens or a part of the official $500 billion in foreign-exchange reserves. When Soumya Kanti Ghosh, the chief economist at the State Bank of India, the country’s largest lender, sought to deflate the trial balloon this week in an op-ed, it became clear that the idea was gaining traction.

Indians own 25,000 tons of gold, roughly one-eighth of the metal ever mined. Households usually keep gold in the form of jewelry, not bars, and can pledge it against loans. Why would they sell family heirlooms and wedding gifts to the central bank to watch them melt in a government furnace? The idea of using foreign reserves as collateral is more perplexing. Those are already the Reserve Bank of India’s assets, matched by liabilities — money — on the other side of its balance sheet. To create more rupees via this route, the RBI will have to buy more dollars from banks and give them newly minted currency.

The only point of all this rigmarole is to refrain from issuing government debt and save India’s credit rating, hovering one misstep away from junk. However, investors aren’t naive. Swapping people’s gold for cash that buys them a few warm meals and a month or two of rent isn’t going to make bondholders optimistic about a revival of growth. And if, say, $100 billion of reserves are somehow sequestered to raise more funds, they’ll be unavailable to settle foreigners’ claims. This could be problematic, given India’s history of current-account shortfalls.

Why not drop the subterfuge, openly run large government deficits, and monetize them? Untimely fiscal prudence would cause the debt-to-gross domestic product ratio to jump to 83% in the fiscal year through March 2021, from an estimated 70.9% in fiscal 2020, Bloomberg Economics’ Abhishek Gupta projected last month. This week, he slashed his growth estimate to a 10.6% drop, from 4.5% previously, and raised his forecast of debt-to-GDP to 91%.

The more this extra debt gets parked with the RBI, the less the pressure on the bond market to finance it. Public borrowing doesn’t cause a crunch when there’s little private credit demand. Difficulties arise because in a developing country, people’s expectations of future inflation aren’t anchored to a central bank target. Labor and capital don’t always move efficiently to where they’ll be productive. Also, while advanced nations can withstand large swings in exchange rates, emerging economies rightly worry about a dollar shortage. Since investors know all this, they want to leave before others do.

If the central bank boldly supports fiscal expansion, the 250 basis point excess yield investors are demanding for preferring 10-year Indian government bonds to three-month Treasury bills — triple the spread from a year ago — could decline. Lower long-term borrowing costs could even encourage issues of perpetual sovereign debt, an option SBI economists are recommending.

Incomes and consumption are cratering, but as long as the state’s power to tax them isn’t durably impaired, it doesn’t require collateral to borrow. Even if they don’t buy the whole MMT package, skeptics can safely take this one lesson home. Much better than plotting to beg, borrow or steal private property or double dip into foreign reserves.

(Disclaimer: Views expressed are author's own)