Dr Ashwani Mahajan
Although Finance Minister Nirmala Sitharaman did not acknowledge in her Budget speech that the Government’s revenue fell short of budget estimates of 2018-19, if we look carefully, the revised revenue estimates of 2018-19 are much lower than the Budget. This shortfall is seen in both direct taxes and direct taxes.
But the Central Government repeatedly reiterated its commitment to keep fiscal deficit lower, which was restricted to 3.4 per cent of the GDP in 2018-19, and would be brought down to 3.3 per cent in the year 2019-20. In the last five years, this approach of keeping fiscal deficit low has been much appreciated, as this Government was able to keep the price line under check, which came as a big relief to the common man.
When the total expenditure of the Government is more than its revenue receipts and capital receipts, this difference is termed as fiscal deficit. This fiscal deficit at present is compensated by borrowing from the public. So far, the Indian Government did not take any loans by issuing sovereign bonds in foreign exchange to compensate Government spending.
Resurgent India Bonds were issued for investment by non-resident Indians during Atal Bihari Vajpayee’s regime. It got a huge response and the country was able to attract $3.5 billion then. Although the Indian government has been taking loans from many institutions, including international financial institutions such as the World Bank, International Monetary Fund, Asian Development Bank etc., and has also made commercial borrowings, loans were not raised by issuing sovereign bonds in foreign currency.
Government’s View
Sitharaman, in paragraph 103 of her speech, said something that had never been said in a Budget speech before. “India’s sovereign debt in its GDP is the lowest in the world, which is below 5 percent. The Government will begin to increase a portion of its gross lending program in foreign exchange in overseas markets. This will also have a beneficial effect on the demand of Government securities in the domestic market,” she noted.
Our GDP is $2.8 trillion today, i.e. 2,800 billion dollars. If loan is raised equivalent to 10 per cent of the GDP, it would mean a loan of 280 billion dollars. In Indian currency, it turns out to be 19 lakh 15 thousand crore rupees.
However, according to the latest news, India’s foreign exchange reserves have broken all records and reached almost $430 billion. In such a situation, there is no justification for taking a loan as a foreign currency.
Government sources say that foreign borrowings are currently less than 5 per cent of the GDP and can be easily increased to 15 per cent. In such a situation, the question that arises is: can the present Government put a cap on foreign loans which no future government can breach? What is the guarantee that the governments of future will not raise this loan further? At the same time, there is no visible strategy to increase foreign exchange earnings in the future to reduce the risk of going into debt trap.
International Experience
To take this decision, we must look at the experience of countries that have taken loans from international markets to meet their government deficit. The experience of these countries has been far from good.
Indonesia’s foreign debt today is 36.2 per cent of the GDP, in Brazil it is 29.9 per cent, in Argentina it is 51.9 per cent, while Turkey and Mexico this burden stands at 53.8 per cent and 36.5 per cent of their respective GDPs. Their respective decisions to take foreign loans have trapped them in such a vortex that now they are raising even more loans to avoid sovereign default.
The reason for this is that foreign loans have to be repaid in foreign currency (say, dollars). Given deficit in the balance of payments and resulting shortage of foreign currency, these countries are pushed into foreign debt trap. These countries have become examples of economic mismanagement. After trapping many countries in this nexus, the rich countries, which are in the lead role of international financial institutions, have started dictating their terms and including tariff reduction among other things.
For instance, to help Indonesia come out of debt distress, IMF offered a bailout; however, in return it demanded some fundamental financial reform measures: the closure of 16 privately-owned banks, the winding down of food and energy subsidies, and it advised the Indonesian Central Bank (Bank Indonesia) to raise interest rates.
Not Really Cheap Foreign Loan
It is said that foreign currency loan from foreign countries is cheaper and therefore makes fiscal management easy. No doubt, nominal interest rates are low in foreign loans and since international agencies are rating India relatively better, we can enjoy benefit of lower interest rates. Those who favour foreign loans may say that we can take less expensive loans from abroad and reduce Government’s debt cost.
But this argument may hold good only in the short run. Given the low interest rate, we forget the upshot of currency risk. We must not forget that sovereign foreign currency borrowing and resulting debt servicing multiply pressures for devaluation, which may actually increase real burden of payment in rupee. Therefore, foreign loans are not at all cheap in the long run.
Despite not taking foreign loan in the past, rupee has been devaluing in the past. As per a rough estimate, our devaluation rate has been close to 6 per cent annually in the recent past. If we tread this path of foreign borrowing, this rate may get accentuated. Therefore, while estimating the rate of interest and basic payoff, the risk of currency risk cannot be ignored.
We have a speaking example before us. Significantly, a large number of Indian companies has raised loans from overseas for want of cheap interest. They originally thought that they are getting loan at a lower rate of interest of 3 per cent to 4 per cent, as the finance minister perhaps has been told.
However, as the rupee depreciated by year-to-year, these companies went into heavy losses due to the hike of interest and repayments liabilities. Learning from that experience, private companies are largely avoiding foreign debt and have started borrowing domestically.
High Risk of Rising Inflation
If the Government starts borrowing in foreign currency to finance its expenditure, we must be prepared for yet another risk: inflation. If the Government borrows in foreign currency, then in order to spend it domestically it will have to get the same converted into rupee from the Reserve Bank of India. This is bound to increase the risk of inflation in the country. The Government has been claiming to be fiscally prudent with lower fiscal deficit (proposed fiscal deficit of only 3.3 per cent in 2019-20). If we go on the path of foreign borrowing, there will be no benefit of keeping the fiscal deficit low. This phenomenon has been seen world over, wherever foreign currency loans were raised.
The Government must understand that this is a big decision and before taking this step on the advice of the bureaucracy, it should consult stakeholders, namely economists, monetary policy experts and foreign currency and international trade experts.
(The author is Associate Professor, Department of Economics, P.G.D.A.V. College (University of Delhi)
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