External borrowing move marks a structural shift
Although the finance minister did not specify how much will be borrowed in foreign currencies, economists caution the move would increase India’s exposure to the volatile world of global financial markets.Updated: Jul 07, 2019 14:42 IST
The Union budget’s announcement that the government will shop abroad for loans denominated in foreign currencies to meet a part of its total borrowing marks a structural shift in the way India deals with its budgetary constraints, revealing the Narendra Modi government ‘sappetite for risk.
This budget detail did not hog the headlines, but the move will weld India much more firmly into the globalised financial markets, of which New York, London, Singapore and Tokyo are the capitals, bringing with it both risks and benefits.
India’s sovereign external debt-to-gross domestic product ratio is among the lowest globally, less than 5%, finance minister Nirmala Sitharaman said in her budget speech on Friday.
This external borrowing “will also have beneficial impact on demand situation for the government securities in domestic market”, Sitharaman said.
Although the finance minister did not specify how much will be borrowed in foreign currencies, economists caution the move would increase India’s exposure to the volatile world of global financial markets.
India has shied away from raising sovereign debt in global money markets to mainly shield itself from being impacted by global financial crises.
In fact, this is why the country was able to quickly recoup from the global financial crisis that peaked with the collapse of investment bank Lehman Brothers in 2008.
“One of the biggest hallmarks of Indian economic policy has been to protect the domestic economy from external shocks. This kind of policy measure has helped India many number of times, even without many people realising it because global upheavals did not even touch us,” said NR Bhanumurthy, an economist with the state-run National Institute of Public Finance and Policy.
The government did weigh the options of external borrowing in 2013, but the then- Manmohan Singh government decided against it. To raise the money needed, one of the first things then Reserve Bank of India governor Raghuram Rajan did was to launch a scheme for foreign currency non-resident (FCNR) deposits, which helped raise $33 billion.
To be sure, raising sovereign debt in foreign currencies does have its own merits.
The budget is focused on cranking up private investment, for which interests rates need to be low. Both governments and private firms go to same money market to finance their borrowing needs. Government typically raises loans by issuing bonds.
Since capital is always scarce, the government often raises the interest rate it is offering on its bonds in order to hog most of the loans, leaving little for the private sector. This leads to what economists call the “crowding out” effect, which ultimately hurts private investment. This is a key reason why the government has decided to borrow in foreign currencies.
“Crowding out is one thing. The government’s assumption that external borrowing will keep interest rates low may not be accurate. Despite lowering of interest rates by RBI, overall interest rates haven’t come down much,” Bhanumurthy said.
According to former Reserve Bank governor C Rangarajan, external borrowing also means contending with exchange rate risks, i.e. the uncertainties associated with the value of dollar versus rupee.
The government’s securities market is currently immune to the China-US spat and Iran-related developments.
Bhanumurthy said when external borrowing opens up the government securities market to foreigners, it exposes India to risks of global shocks.