Government Treads Tentatively Towards Foreign Currency Borrowings
The Indian government’s decision to borrow in foreign currency has benefits but will need to be treated with extreme caution.
The idea of the Indian government borrowing in foreign currency has come and gone many times in the past. It was discussed in the 1990s, in the early 2000s, in 2013 and many times in between.
Each time the possibility of a sovereign foreign currency bond was put on the table, it came from a place of vulnerability. That vulnerability, until now, was the need to shore up foreign currency reserves or support the rupee. This time, though, it is a different vulnerability that has prompted the government to announce that it will consider borrowing overseas.
Fiscal pressures and high public sector borrowing requirements are crowding out private borrowers and keeping interest rates high. The government is hoping that by diverting a part of its borrowings overseas, it will free up the domestic financial savings pool for private use and bring down interest rates. The addition to foreign exchange reserves will be a useful byproduct.
There are potential benefits of the sovereign borrowing overseas, such as a lower cost of borrowings, easing pressure on domestic interest rates and providing a benchmark for Indian corporates. However, there are significant risks too, which will need close monitoring.
Is India Ready?
The key question is whether India is ready to go in this direction.
It is believed that many former governors of the Reserve Bank of India have pushed back against the idea of the Indian government going overseas to borrow. From C Rangarajan to YV Reddy, Bimal Jalan and Raghuram Rajan are all said to have seen this option as undesirable.
- C Rangarajan, in a conversation with BloombergQuint, said that foreign currency borrowings expose the sovereign to foreign currency risk.
- Raghuram Rajan, in comments made in 2013 when he was chief economic adviser, had said that getting foreigners to buy debt in the domestic market is a preferable option.
- YV Reddy, in a speech in 2008, had said that given the large revenue deficit and the magnitude of public debt, raising foreign currency sovereign debt was undesirable.
Has the situation changed dramatically since then to justify a change in stance?
The data suggests that the central government’s fiscal and revenue deficits have come down substantially from a decade ago, with fiscal deficit now targeted at 3.3 percent of GDP and revenue deficit at 2.2 percent of GDP. However, the general government fiscal deficit, which includes centre and states, remains high at above 6.5 percent of GDP.
Also the attempt to bring down the government’s revenue deficit to zero, to ensure that the government does not borrow to meet regular expenditures, has been all but abandoned. In addition, in the last two years, concerns about under-reporting of the fiscal deficit have re-emerged, raising questions about the true extent of fiscal deficit.
The current account deficit, too, remains volatile. Oil prices remain the key determinant of whether India’s current account deficit is in check. Another way of looking at the current account deficit is the gap between savings and investments. Since the idea to borrow overseas stems from the inadequacy of savings, that in itself suggests a vulnerability.
The government is trying to project a degree of confidence in the international markets, which may be premature, cautioned economist Indira Rajaraman in an interview with BloombergQuint.
I would have liked to see more fiscal consolidation, more conservatism on that front. I don’t think this gamble of borrowing abroad at this juncture was quite justified, except if it is kept in prudential limits.Indira Rajaraman, Economist & Former RBI Central Board Member
The International Experience
The other way to assess the Indian government’s plan is to see whether other emerging economies have benefited from such foreign currency borrowings.
Data from the Institute of International Finance shows that the Indian government’s foreign currency debt is among the lowest across emerging economies. But it also shows that many Asian peer economies have chosen to keep foreign currency debt low. Indonesia is an exception to this.
Indonesia’s experience, however, has not been encouraging. One of the reasons Indonesia found itself facing turbulence in the last few years, along with the likes of Turkey and Argentina, was because of its stock of external debt. However, in the case of Indonesia, the ratio of foreign currency debt to total government debt has been as high as 40 percent at times, increasing the country’s vulnerability to global market linked volatility.
India, in contrast, has benefited from its low dependence on foreign currency debt and international credit rating agencies have seen this as a point of strength for the country.
Should India decide to move in the direction of raising government debt in foreign currency, it would need to set strong prudential limits.
We would need to ensure that overall foreign currency debt, including that of corporations, remains within a prescribed limit. In December 2018, the RBI had said that the stock of external commercial borrowings will be restricted to 6.5 percent of GDP. Government foreign currency debt should also be subjected to a similar prudential limit. Ideally, there should be a limit on the total external debt pool, government and corporations included.
Similarly, India currently restricts the proportion of government debt that foreign investors are allowed to hold. At present, that limit is set at 6 percent of the outstanding stock. Foreign currency debt should be included in this pool even though this would restrict the extent of foreign investment India can draw into local currency denominated securities.
Other indicators, such as the ratio of external debt to foreign currency reserves, would also need to be watched far more closely should the Indian government start to borrow in overseas markets.
The Political Economy Question
The final, and perhaps the trickiest, question is one related to the political economy.
Once we open this avenue of foreign currency borrowings by the government, can we be assured that governments of the day will not give in to the temptation to borrow more and more overseas and, in turn, increase India’s long term vulnerabilities.
Can we be confident that each successive government will use this route conservatively and that the RBI leadership will be strong enough to block any attempts to loosen prudential limits for short term gains?
Former RBI governor YV Reddy had once said that: “My single objective is to protect the Indian economy from the Government of India.” Should the Indian government open up the country to potentially new risks, the RBI’s job in ensuring adequate checks and balances on that new risk will only get tougher.
Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.