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 pre-requisite. If markets suspect errors in budget estimates, off-budget borrowing or delaying payments to achieve annual fiscal targets, foreign lenders could mistrust the government 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 Rs 100 lakh crore of infrastructure investment, and build a $5 trillion economy.
Fear of foreign borrowing
Since the 1991 balance of payments crisis, sovereign foreign borrowing has terrified the government and the Reserve Bank of India. The proposal has come up internally a few times, but been shot down due to concerns that cheap foreign money will be too attractive for governments and they may borrow too much. This could lead to a balance of payments 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 the RBI have been more comfortable with FDI 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 was feared would come with it.
In the last few years, the India’s foreign debt policy has been liberalising. This has happened for rupee-denominated bonds for both government and corporates, 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.
Room to borrow more
The government of India has so far not borrowed directly in the international bond markets. In the past, when the government has borrowed in times of need, things have been done through public sector banks. ‘Resurgent India Bonds’ and ‘India Millennium Deposit’ bonds were issued through banks like the State Bank of India, and were sold to NRIs, who were given high interest rates. The 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 and 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 per cent of the GDP being currently borrowed in foreign currency by the Indian government, there is room 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 to 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 the capability to service it. If the ratio of debt-to-GDP grows very fast, then one would reach a point where one is 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 to trust the country’s own data. Foreigners must also trust India’s data. If the data is untrustworthy, the cost of borrowing will be higher. The country will be paying for a higher expectation of default, even though it may never intend to default.
It will be thus in India’s national interest to produce good quality government data and national accounts and stick to the FRBM and inflation target in letter and in spirit.
The author is an economist and a professor at the National Institute of Public Finance and Policy. Views are personal.
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