The Reserve Bank of India (RBI) governor D Subbarao on Wednesday proposed to the government to put a cap on the public debt. If the government “borrows and squanders that money away on unproductive current expenditure”, both fiscal sustainability and growth would bejeopardised, he said, delivering a keynote address at the second International Research Conference — 2012, organised in Mumbai, attended by central bankers, economists and policy makers around the globe.

He warned the government that huge public debt will force the central bank to complying meekly to the fiscal dominance and overriding the central bank’s need to focus on a stable monetary environment. India’s public debt is currently estimated to be 65 per cent of GDP, one of the highest among emerging econo­mies.

“In the case of sovereign debt, there is an inflexion point beyond which fiscal deficits militate against growth. Government borrowing is not bad per se, but excessive borrowing is. There is therefore a need to cap total public debt as a proportion of GDP,” said the governor. Besides, the RBI governor has highlighted the importance of enhanced spending to improve human and social capital, and physical infrastructure.

Large government borrowing, he said, gives little choice to central banks. There is often only a thin line, and the interpretation of the motivation for outright Open Market Operations (OMOs, or buying back government bonds from the market to support the liquidity needs of the government) could vary depending on the circumstances. If central banks do not conduct OMOs, it will loose control over financial stability and if they conduct OMOs, they risk loosing control over price stability, he added.

“But at times, OMOs could be motivated by the objective of providing liquidity to support government borrowing or of reducing the yield on treasury bonds to enhance debt sustainability. It then becomes a case of acquiescence (comply passively) in fiscal.”

He also raised concerns on whether monetary policy of central governments around the world is becoming hostage to fiscal compulsion. In India, the question has been whether the OMOs conducted by the RBI to manage systemic liquidity are acting as a disincentive for fiscal discipline. The questions are being raised whether central banks around the world are forced beyond their comfort zone to subordinate the monetary policy stance to government’s fiscal stance.

At the heart of these concerns is whether monetary policy is once again becoming hostage to fiscal compulsions. The specifics of the debate vary but the basic issues are similar. In the US, the debate is over the trade-off between short-term fiscal stimulus and long-term fiscal consolidation. In the euro area, the question is about the shared benefits of a monetary union without the shared responsibilities of a fiscal union.

Subir Gokarn, deputy governor, RBI, said, “When inflation goes beyond the threshold of 4 to 6 per cent, then it becomes inimical to growth and the monetary stance shifts to inflation control.”