Be safe stay home

Be safe stay home

Premature for government to borrow abroad, its risks outweigh the benefits.

Arguably, the most consequential measure proposed in the budget is one which will open the door for sovereign borrowing abroad. Finance minister Nirmala Sitharaman observed that India’s external debt to GDP is less than 5%. Also, shifting a part of government’s borrowing to international markets will create more space for private sector loans in India. Sovereign borrowing abroad has been discussed within government for almost three decades, but the idea did not gain traction on account of attendant risks. So, what has changed?

Chief economic adviser Krishnamurthy Subramanian believes it’s a “once in a generation opportunity”. His case rests on three intertwined factors. One, the differential between real interest rate in India and some overseas markets is significant. Therefore, overseas debt will reduce government’s interest cost. Two, the primary deficit is marginal; it’s interest costs which really contribute to fiscal deficit. Three, the exchange rate differential between countries is determined by differences in growth rates. As India is one of the fastest growing economies in the world, it makes sense to borrow in currencies of economies growing at a much slower rate.

The argument is not convincing enough. The explanation on exchange rate differential is about the long run. However, risks of sovereign borrowing emanate from proximate developments. The risk is transmitted through channels which link domestic and foreign markets. To illustrate, India’s deficits are understated, as shown by budget documents and CAG audits. There is a lot of expenditure which doesn’t reflect in the stated deficit numbers because of accounting quirks. In the event of an unfavourable development, the quality of India’s numbers will assume disproportionate importance even if the amount borrowed is small. Another consequence will be that the ever present risk will further shrink space for monetary policy. Therefore, it would be prudent to stick to the domestic market for now.