7 PM | Time ripe for sovereign external borrowing | 17th July, 2019

Context:sovereign borrowing and its impact on Indian economy

Sovereign borrowing means raising the money from foreign markets by issuing government bonds by the government/central bank of a country. A sovereign debt or sovereign loan is not owed by a country’s citizens, but by its government. It is not considered a national debt and the money obtained is used at the discretion of the borrowing government. It can be given to banks or private companies or used to pay for infrastructure projects. The government doing the borrowing may adapt different solutions to guarantee the repayment of the loan, such as by printing money or increasing taxes. Sovereign debts can differ in terms of the currency used upon issuance, maturity and interest rates.

Need for sovereign external borrowing in India:

• Infrastructure needs: India has a requirement of investment worth Rs 50 trillion (US$ 777.73 billion) in infrastructure by 2022 to have sustainable development in the country. India is witnessing significant interest from international investors in the infrastructure space. Global experience is that most of this investment would need to come directly or indirectly from government. Private enterprise can play only a marginal role, in view of the higher risks, lower returns and longer gestation periods of the underlying investment.
• Interest rates: India with a deficit of savings over investment, at the same time global interest rates are at historic lows, so the government should tap the potential and allocate needed money for country’s growth and development. Direct borrowing by the sovereign is always cheaper than for any other entity, it will be a net welfare gains for the economy.
• Favorable internal climate: the sovereign’s debt as a percentage of GDP stood at 3.8%. The current account deficit (CAD) as a percentage to GDP was 2.1% in 2018-19, which can be financed by capital flows. Though economic growth has slowed down, it is highest in the global context and is accompanied by a benign inflation outlook.

• Savings: India’s overall savings rate has declined to 30% from 34.6% over five years, ending FY2016-17. The worst dip was seen in the household sector, the largest contributor to savings in the economy, dropping to 16.3% from 23.6% over the period. So with decline in savings and costly external commercial borrowings, sovereign borrowings look promising.

• Foreign reserves: the robust forex reserves of around $428 billion as on June 28, 2019, global investors will draw enough confidence to invest. So the risk of default is less.
• Integration: According to economic survey 2018-19, Indian economy is the sixth largest economy in the world, but the economy is less integrated with respect to developed countries. So by sovereign borrowing Indian economy will be integrated more with the world economy.
• Currency swap agreements: the government of India has currency swap agreement for $ 75 billion. Moreover huge NRIs and other high net worth individuals of Indian origin will give hedge for low cost sovereign borrowing.

Challenges to sovereign external borrowing for India:

• Never borrowed: The idea of borrowing by issuing bonds is being shelved by experts, who believe there is reason India never resorted to such a move despite staring at a slowdown in the economy during 1990-91, 2007-08 and 2013.
• Rupee appreciation: Indian rupee is appreciating slowly after reaching 75rs per $. Present Indian rupee exchange with dollar is approximately 70rs. With foreign borrowing rupee will appreciate and will have multiplier effects on Indian economy.
• Exports: The government unveiled its first foreign trade policy for 2015-2020 in April, setting a merchandise and services export target of $900 billion by 2020, almost double the $465.9 billion achieved in 2013-14. However, with the fragile global economic recovery and increasing protectionist economic policies, India is re-assessing the exports situation. At this situation appreciating rupee will be disastrous effect on foreign trade.
• Imports:government of India launched “Make in India” scheme to promote manufacturing in India and taking manufacturing contribution to GDP to 25% by 2022. But with the appreciation of rupee, imports will be cheaper and it will impact on make in India initiative.
• Policy uncertainty in western countries: after the global financial crisis in 2008, most of the developed countries followed the easy money policy and pumped huge money in the global market for recovery from the crisis. With easy and cheap money flow into emerging markets like India had painful impact on Indian currency when fed reserve tried to raise interest rates in 2013. So there is no certainty in global currency market.
• Latin American countries experience: Take the case of Latin American countries. In the aftermath of the oil price hikes in the seventies when the global markets were awash with Petro dollars, they borrowed cheap and wide. But when the global financial crisis broke in the late eighties and it was followed by a string of Latin American defaults.
• Fragile global economy: Borrowing will set in motion a process which will integrate the Indian economy more closely with the global scenario. Since there is currently some disenchantment with globalization, the correct intellectual approach should be to wait and watch.

Measures to improve the ecosystem for borrowing and capital inflows in India:

• Currency swap agreement: India and Japan had agreement of $ 75 billion. The swap agreement is a risk free option and it is a win-win situation and promotes bilateral agreements with respected country. On the same lines government should promote swap agreement with other countries.
• FDI and FPI liberalization:  majority of the FDI investment comes through automatic route. But the realization of actual FDI is not up to the level of promise. Government should open the insurance sector and pension sector along with increase in limits of FPI investment in government securities.
• Rupee denominated bonds: Indian government should raise the rupee denominated bonds in foreign markets where repayment in rupees will be less risky.

Way forward:With reasonable economic growth, benign inflation outlook, a resilient external sector and, above all, political stability, it is an opportune time for the authorities to enter the global market with sovereign bond borrowing. Testing the market with a new approach to raise sovereign external debt is one thing, but falling into a trap by repeated floating of bonds and unwarranted enthusiasm is quite another. So the government should maintain the balance between capital flows and raising sovereign borrowings, for the growth of economy. Source:https://www.thehindubusinessline.com/opinion/time-ripe-for-sovereign-external-borrowing/article28490230.ece.