Debt fears over India’s decision to borrow from abroadsento
While presenting her maiden annual budget on 5 July, India’s first full-time female finance minister, Nirmala Sitharaman, indicated that her government was planning to borrow more money from abroad.
The reason, she said, was that the ratio of India’s sovereign external debt to gross domestic product (GDP) is among the lowest in the world – less than 5%.
Like most countries, India runs a fiscal deficit, which means that it spends more than it earns, and has to borrow money to make up for the difference.
In 2019-20, the government is expected to run a fiscal deficit of about $103bn (£82bn), or about 3.3% of GDP.
Typically, the government would have borrowed domestically. The problem is that the federal government is not the only one borrowing money.
India’s state governments also run their own fiscal deficits and need to borrow money in order to make up for the difference. Then there are state-owned companies which also borrow heavily.
Meanwhile, the household savings – bank deposits, insurance funds, mutual funds, currency – which finance these borrowings have been declining over the years.
This has led to a situation where interest rates remain high, despite inflation coming down and the central bank cutting its repo rate three times this year. (The repo rate is the interest rate at which the central bank lends to commercial banks).
All the borrowing by the government and its companies – which amounts to 8.5% of GDP – has meant there is less money for private companies to borrow.
Finance Secretary Subhash Chandra Garg has indicated the central government will borrow $10bn from overseas during this financial year. The theory is that by borrowing abroad, the government won’t be putting pressure on Indian savings, like it has in recent years.
And there will be less crowding out of private companies looking to borrow and, in the process, slightly lower interest rates.
This is important because private investment in India has been down in the dumps for the last few years.
The major reason is that many private companies went on a borrowing binge between 2004 and 2011, and have since found it difficult to repay the loans, primarily to India’s state-owned banks. Banks, in turn, don’t want to lend to companies.
Many economists and bureaucrats believe that high interest rates are also holding private investment back.
But the government can borrow money and lower interest rates another way too.
It just needs to expand the limits it has set on foreign investors investing in India’s debt market – government or corporate bonds, for example.
Allowing more foreign money here will mean less pressure on India’s domestic savings. That will lead to lower interest rates, without having to borrow money from abroad.
And instead of repaying the loan in dollars or any other foreign currency, the government will have to repay the loan in rupees, which as we shall see, makes immense sense.
Borrowing in dollars is expected to be cheaper, and hence, bring down the interest that the government pays on its debt.
But this comes with a corollary.
Assuming the borrowing is in US dollars, the rupee is likely to depreciate against the dollar in the long-term given that India’s inflation is significantly higher than that of the US. Then the lower interest rate cost will be more than made up for by the government needing more rupees to buy dollars to repay the loan as well as pay interest on it.
So, not everyone is happy with the decision of the government to borrow abroad.
There are also other negatives that come attached with any country borrowing abroad.
First and foremost, it will lead to the rupee appreciating against the dollar, at least in the short-run.
When the bonds are sold and the dollars (or any other foreign currency for that matter) are brought back to India, they will have to be converted into rupees.
This will push up the demand for rupees and eventually lead to the rupee appreciating in value against the dollar. In the short-term, an appreciating rupee will hurt India’s exports, which are struggling already.
It will also make imports cheaper and hurt domestic producers competing against them.
In the recent past, India has gone back to a policy of protectionism. Hence, there is a lack of policy consistency here as far as the government is concerned.
And some economists are also worried about the currency risk that accompanies any foreign borrowing.
When a government borrows in the domestic currency – like the Indian government borrowing in rupees – it always has the option of printing currency and repaying the debt – or what economists call inflating the debt away.
That option doesn’t exist when the borrowing is not in the domestic currency. India’s central bank cannot create dollars out of thin air. It can only print rupees.
As former finance minister Arun Jaitley wrote in an official paper on government debt last year, “Public debt is predominantly of domestic origin and denominated in domestic currency, insulating the debt portfolio from currency risk.”
In fact, many countries have faced financial crises in the past because of their inability to repay money borrowed in a foreign currency. Latin American countries like Argentina, Brazil and Mexico are a good example; and something similar also played out in Indonesia and Thailand in the late 1990s.
This possibility has some economists worried.
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But currency risk becomes a worry only when the foreign borrowings of the government reach a certain size.
Foreign borrowing of $10bn shouldn’t lead to any worries on the currency risk front, especially since India’s foreign exchange reserves, as of June 2019, stood at $428bn.
Having said that, the government shouldn’t get used to the idea of borrowing from abroad.
History shows that it’s easy for governments to get addicted to foreign debt, which seems cheaper in the short-term.
Given that we live in an era of easy money, if the Indian government wants to borrow, money will be easily available to it. This could cause a few problems.
One, it will increase the currency risk.
And two, given the fact that Indian economic statistics have been questioned in the recent past, any international crisis can have a disproportionate impact on India, even if the international borrowings are not huge.
Vivek Kaul is an economist and the author of the Easy Money trilogy