As the Indian government seeks to open itself to external sovereign borrowings, it would make sense to look at the history of economies which have resorted to such borrowings to fund their own spending. Greece tops the chart of such economies which have had a deadly tryst with external debt. For those who might find the comparison of India with Greece odious, it might be a revelation to know that the ‘fastest growing economy’ in the world with a 15 per cent debt-to-GDP ratio in 1973 had become a debt-stricken economy living at the mercy of its external creditors by 2010.
The Finance Minister has announced that India will use foreign savings to fund its gross borrowing needs (fiscal deficit), since India’s external debt to GDP has been the lowest globally at less than 5%. Strange logic, given that India has managed to grow through domestic borrowings so far; and in fact, has achieved this difficult task of low external debt to GDP ratio despite its history of fiscal mismanagement.
There are at least three reasons why the government should not borrow externally:
One, what happens with the government, unfortunately, does not remain with the government. Government bonds, typically 10-year government bonds- the instruments through which the government borrows- are considered gilt-edged or risk free. They carry a rating called the Sovereign rating, which itself depends on several factors, and impacts the rate at which the government can borrow. If for some reason, such bonds are perceived risky, because of which the government has to pay more to borrow; this would naturally increase the rates at which loans can be borrowed by the ‘more risky’ individuals and corporates. Thus, home loans, loans of the small and medium sector, as also the large Indian corporates will become expensive.
Turning to facts: Even in 2019, notwithstanding our distinction of being the world’s fastest growing economy with a low debt of 44.5 % of GDP, India has been rated at the lowest investment grade of ‘BBB Minus’ by the major credit rating agencies (Standard & Poor’s and Fitch), while Moodys has rated us just a notch above investment grade at Baa2. India’s weak fiscal position has been held responsible for such ratings.
It is important to note that your rating does not depend on your growth rate, which itself is being questioned for its credibility. Rather, it depends on the Combined fiscal deficit position (of the centre and the states), as also on the inflation rates, relative to the peer countries. This has been cited by Standard & Poor’s earlier, and Fitch in 2019 to keep India at almost junk bond status.
Two, if we can borrow and repay in Indian rupees, it should be fine. However, borrowings and repayment both will need to be in dollar terms, and hence vulnerable to rupee depreciation. To see this in perspective, the rupee has moved from Rs 46.22 per dollar on July 15, 2009 to Rs 68.56 per dollar on July 13, 2019, a 48 per cent depreciation. Whether you or the government borrowed a dollar 10 years back, you would now need more rupees to repay the loan. How does this make for good fiscal economics?
Three, high levels of debt-to-GDP per se mean nothing; Japan and US have managed to enjoy very high levels of investor confidence despite high debt-to-GDP rates of 235.96% (of which 81% is external debt) and 108.02% (of which 96.5 % is external debt). On the contrary, countries like Mexico and Brazil had defaulted in the 1980s despite low debt-to-GDP ratios of 50 %.
India’s fiscal problems are largely structural. Trying to find quick-fix/short-term solutions for such structural problems through external debt financing would be fool- hardy.
Greece, through its default history, exhibited low tax-GDP ratios, high public spending and the resulting fiscal mismatches; inability to curb its revenue deficits, and top it all, lack of credible financial data. The Greek story may have shaped up differently if it had not been addicted to foreign savings. India’s fiscal history may have some parallels with Greece, in the sense that fiscal deficits have been used to fund a consumption-oriented, demand-driven economy.
Ancient wisdom speaks of the solution lying within the problem itself. The solution to bridging higher fiscal deficit then lies in increasing public savings and through domestic borrowings itself. It also lies in undertaking structural reforms which would reduce the scope for running huge fiscal deficits. History is a great teacher for individuals and nations, if only they were to learn and not repeat other’s mistakes.
-Tulsi Jayakumar
The writer is Professor of Economics and Chairperson, Family Managed Business at SPJIMR. Views are personal.
