Sovereign foreign borrowing is a bold move
It is in India’s national interest to produce good quality data and stick to fiscal discipline and inflation targets .Updated: Jul 12, 2019 08:33 IST
The finance minister, Nirmala Sitharaman’s proposal that the Government of India borrow in foreign currency is a bold move. To reap the benefits of foreign sovereign borrowing, fiscal discipline is an essential prerequisite. If markets suspect errors in budget estimates, off-budget borrowing, or delayed payments to achieve annual fiscal targets, it can make foreign markets mistrust the government of India and raise the cost of borrowing. While India has a Fiscal Responsibility and Budget Management (FRBM) Act and an inflation targeting monetary policy in place, it needs greater fiscal transparency.
Sovereign foreign borrowing in international markets would help in attracting more foreign capital and pushing up domestic investment beyond what India saves. The risk free rate can serve as a benchmark for dollar borrowing by Indian corporates. It can help reduce the cost of capital for both governments and corporates. Foreign borrowing is critical if the government is to meet its target of ~100 lakh crore of infrastructure investment, and build a $5 trillion economy.
Since the 1991 balance of payment crisis, sovereign foreign borrowing has terrified the government and the Reserve Bank of India (RBI). The proposal has come up internally a few times, but been shot down on concerns that cheap foreign money will be too attractive for governments and they may borrow too much. This could lead to balance of payment crisis, currency depreciation and greater difficulty in paying back the loan. This is the first time the proposal has made it to the budget speech.
When fiscal deficits become large, they spill over onto the current account and the country ends up with a large current account deficit. This difference between what the country produces and what it consumes, or between its exports and imports, is financed by money from abroad or capital inflows. Until now, the government and RBI have been more comfortable with the Foreign Direct Investment and Foreign Portfolio flows, and less with foreign debt. Over the years, the fear of hot money has reduced as despite having large foreign portfolio flows in the equity markets, India has not witnessed the crisis that were feared to accompany them.
In the last few years, India’s foreign debt policy has been liberalising. This has happened for Rupee denominated bonds for both government and corporate, where limits for the bond holding by foreigners have been slowly hiked. India has also liberalised the regime for external commercial borrowing, or dollar borrowing by corporates.
The Government of India has so far not borrowed directly in the international bond markets. Instances in the past when the government has borrowed in times of need has been done through public sector banks. Resurgent India Bonds and Millennium India bonds were issued through banks like the State Bank of India. Bonds were sold to the Non Resident Indians who were given high interest rates. RBI would compensate banks in case they suffered losses due to the currency risk they were taking.
In addition to such emergency borrowing, the Government of India borrows through the bilateral and multilateral route. This is borrowing from countries, at negotiated interest rates in yen, dollar, for example from Japan, and from multilateral agencies like the World Bank or the Asian Development Bank. This borrowing is done by the ministry of finance and rates are concessional. The borrowing flows to central and state governments for projects approved by the ministry.
At present, global money markets are awash with liquidity. Emerging economies are able to borrow at low interest rates. With only 5% of Gross Domestic Product (GDP) being currently borrowed by the Indian government in foreign currency, there is room for the government to borrow more. The question today is whether such borrowing can be done in a prudent manner without raising risks for the economy. Assuming that the borrowing will be kept in control, the next question is how do we keep the costs of borrowing low.
In addition to transparent fiscal data, borrowing abroad should be accompanied by good quality GDP data. The sustainability of debt requires that debt should not blow up beyond our capability to service it. If the ratio of debt to GDP grows very fast, then we would reach a point when we are unable to pay back debt. Since debt grows at the interest rate, and GDP grows at the growth rate of the economy, stability of the debt to GDP ratio requires that the interest rate should not exceed the growth rate of the economy.
To be able to borrow at low interest rates in foreign markets, it is not enough that we trust our data. Foreigners must also trust our data. If the data is untrustworthy, the cost of borrowing will be higher. We will be paying for a higher expectation of default, even though we may never intend to default. It will, thus, be in our national interest to produce good quality government data and national accounts and stick to FRBM and inflation target in letter and in spirit.
Ila Patnaik is an economist and a professor at the National Institute of Public Finance and Policy
The views expressed are personal