This brings us to the second objection to a monetised deficit, namely, that it undermines the autonomy of the central bank. This demand for autonomy, which is a central component of IMF-style financial reform, assumes that once relieved of the task of financing the government's deficit, the RBI would be "free" to use monetary policy as a device to control inflation, manage the balance of payments, and influence growth. The two interrelated means to realising these objectives are seen as controlling liquidity and influencing interest rates.
 
Needless to say, there are strong grounds for scepticism regarding the efficacy of this policy. The limited success of the central bank in its effort at bringing down interest rates and trigger growth, is a case in point. Despite easing liquidity conditions through a variety of means, including periodic reductions in the cash reserve ratio, and despite reducing the Bank Rate or the interest rate charged on bank borrowing from the RBI, real interest rates in India have proved quite sticky. This has forced the government to reduce the interest rate on small savings and provident funds. It is the government rather than the central bank which is at the forefront of the drive to reduce interest rates.
 
But that is not all. IMF-style financial reform has hardly increased the autonomy of the central bank, since it not merely involves curbing the government's borrowing from the RBI, but also liberalising regulation of capital flows into and out of the country. Since such flows are extremely volatile, the central bank is constantly forced to adjust to these "autonomous" capital movements.
 
In recent times, for example, portfolio inflows which went way above the $50 million a day mark, increased foreign exchange availability in the market and threatened to raise the value of the rupee, even when the trade deficit was widening. This has required the central bank to intervene in the foreign exchange market and purchase dollars to stabilise the rupee, resulting in a sharp increase in the foreign exchange reserves with the RBI. Since an increase in the central bank's foreign assets increases high-powered money and therefore the supply of money, monetary policy remains solely concerned with neutralising the effects of foreign capital inflows. Relieved of the dominance of fiscal over monetary policy, the RBI now finds itself straitjacketed by international finance.
 
Finally, the evidence quoted earlier makes clear that even putting an end to the practice of monetising the deficit has hardly affected the fiscal situation. Fiscal deficits remain high, though they are now financed by high-interest, open-market borrowing. The only result is that the interest burden of the government tends to shoot up, reducing its manoeuvrability with regard to capital and non-interest current expenditures. This effect of financial reform on the fiscal manoeuvrability of the State can be assessed by comparing actual fiscal trends with a hypothetical situation where the government had continued financing the same share of its deficit (around 30 per cent) with central bank borrowing as it did in 1989-90.
 
We assume the interest rate on central bank borrowing to be 4.6 per cent, and the interest rate on open market borrowing to be the same as has actually prevailed in individual years during the 1990s. Then, a simple simulation exercise shows (Chart 4), the interest burden in the budget would have risen from Rs. 17757 crore to only Rs. 88464 crore in 2000-2001 as compared with the estimate of Rs. 101266 recorded in this year's budget papers. This close to Rs. 13000 crore or 12.6 per cent saving in interest payments in the terminal year, is obviously the culmination of a rising gap between actual and hypothetical interest payments starting from the mid 1990s when the practice of monetising a part of the deficit was done away with.
Chart 4 >>
 
This cumulative saving would have implied a huge reduction in the size of the fiscal deficit, assuming expenditures remained the same. The gap between the hypothetical deficit and the actual deficit relating to recent years in Chart 5 illustrates this. Over the 1990s as a whole, the cumulative reduction in the deficit would have been more than Rs. 100,000 crore, which is far more than what the government could possibly have mobilised through disinvestment.
Chart 5 >>