1. What is fiscal dominance? Explain in Indian context as discussed in the article.

Fiscal dominance is an economic condition that occurs when a country has a large government
debt and deficit such that monetary policy targets keeping the government from bankruptcy as
opposed to economic targets such as inflation, growth and employment.

In Indian Context, the fiscal dominance is the conduct of monetary policy. Since bank assets are
marked to market, cuts in interest rates induce treasury gains for banks that effectively
recapitalises them. Consequently, rate cuts are preferred by governments needing to inject
capital into public sector banks (PSBs) with NPA overhangs. For similar reasons, liquidity
injections, which raise bond prices, are preferred to liquidity absorptions. Indeed, fiscal
compulsions can induce liquidity policies that undercut the rate setting by the MPC as the two
arms often work towards opposing goals. This contradiction is further complicated by the fact
that the RBI is also the debt management agency for the government with one of its key tasks
being to sell government bonds at the highest possible price.

2. How government is using PSB as a tool for macroeconomic management?

To finance fiscal deficits, PSBs are regularly utilized for resource mobilization. The govt.
frequently announces credit policies to instead of banks allocating the credit based risk on risk-
return management criteria which leads to farcical situation. Well, for supporting farmers
through loan write-offs, meeting employment targets, PSBs are the favored instrument.

3. State the problem identified and reforms suggested by the author?

Problems –

1. The state ownership of banks.

2. The chronically high fiscal deficit run by the consolidated public sector.
3. The widespread perception that market regulators work under close government
direction. 

Reforms –

1. There has to be a wholehearted attempt at privatisation of PSBs.

2. The RBI needs to be relieved of its public debt management role.
3. The RBI has to be empowered to act independently of the government. It is untenable for
government-owned banks to be regulated by an agency that is itself reporting to the
government.

4. What moral hazard does the article refer to?

As the government is using PSB as a tool for macroeconomic management, this sort of state
interface with the business of financial intermediation naturally induces extreme levels of moral
hazard in the behaviour of both debtors and creditors.

PSBs are not incentivised to exercise due diligence since they expect regulatory forbearance
and recapitalisation in the event of rising NPAs on their books. In contrast to the “constructive
ambiguity” that sometimes surrounds prospective bailouts of banks in developed economies,
Patel calls expected bailouts in India “destructive unambiguity.” All sides of the market expect
bailouts and are seldom unpleasantly surprised.

5. Summarize the article in your own words.

The core part of modern economics is the Financial Markets. Business is reluctant to invest out
of retained earnings alone with the matchmaking services of financial markets. The activities
done by the financial markets aren’t easy to prove. The risk has to be less and returns should be
high on savings. However, both these things are contradictory. In the book written by Urjit
Patel, he clearly explains the dark picture of fiscalization of the entire banking infrastructure.
Book written by Acharya throw light on uncontrolled action of the financial and monetary
infrastructure to the fiscal interests of the government. Because of the unhealthy borrows,
creditworthy borrowers pay the risk premia. As the government is using PSB as a tool for
macroeconomic management, this leads to interference of state with the financial markets
that poses threat to both creditors and debtors. 3/4th of the total banking assets in India are
state-banks owned. The authorities should focus on the problems that are raised and that may
lead to major losses. Major reforms are listed in the book also. A good beginning can be by
stopping the recruitment of favored people un such sort of regulatory institutions. One can
continue in his or her career if they go with the good implementation of rules. There should
something be done for financial sector. The major driver for growth and productivity needs to
be iterating and that needs to be properly-functioning financial markets. One should consider
that India is the country in which the regulatory authorities have to do much work in the
financial sector.