Limited external sovereign borrowing may be a boon

Nirmala Sitharaman in the budget presented in Parliament came up with the proposal to borrow in the external markets in external currencies.

Two main reasons given for this proposal are India sovereign external debt is one of the lowest at less than 5 per cent of the GDP and hence external borrowing is a favourable option.

Given the emphasis the budget places on private sector investment to give a boost to the economy this measure would free up domestic funds for private investment since there is not enough domestic household savings to finance enormous needs of the Government and still leave substantial amounts for private sector investment.

This one particular proposal in the budget has drawn the maximum debate in terms of some supporting it as an innovative initiative beneficial to the economy and another set of economists warning against the pitfalls of sovereign external borrowings.

Swadeshi Jagran Manch also joined in the debate arguing against the move and there are reports that the proposal is put on hold but at the same time clarification that government will go ahead with intended external borrowing.

The government needs huge amounts to take up and complete massive infrastructure projects which can play complementary role in attracting private investments.

But if government for this purpose dips into domestic saving to finance its huge deficit then due to the crowding out effect there will be less available for private sector to borrow and the cost of borrowings will also go up.

If part of this is externally funded to that extent more funds will be available for private sector investments at a relatively cheaper rate. This in essence is the rational for external sovereign borrowing.

The other related benefits that would follow are that this will set the benchmark for other external commercial borrowings and since the market will assess the strength of the Indian economy and future volatility while determining the interest rate it would be difficult for the rating agencies to rate the country arbitrarily thus giving us a better rating making external commercial borrowing by private companies that much easier as well.

The government will also be disciplined both on the fiscal and monetary front since international markets will punish any country not able to stick to fiscal discipline in a disproportionate manner.

It is also pointed out by some economist when a country like Indonesia with the higher current account deficit of 2.98 per cent of GDP for 2018 was able to borrow externally at 3.20 per cent we should be able to borrow at more attractive rate given the fact that the current account deficit is 2.1 per cent of GDP and when we are holding onto a record forex reserves of US $426 billions.

Those who argue against the measure have two important cautions to note. One in case, rupee depreciates in future servicing of the external debt becomes that much more burdensome and as with the domestic debt government cannot generate inflation to reduce the real debt burden .

In essence you can cheat the domestic creditor not an external creditor .Even the critics concede external sovereign borrowing in a limited manner is worth experimenting they are more concerned it can become an addiction and in the long run if it becomes huge can create problems.

In this context they make a reference to the Latin American countries where huge external sovereign borrowing coupled with a number of other factors led to serious financial crisis.

Those who are drawing a parallel to Latin American countries financial crisis and warning against external sovereign borrowing are forgetting some essential differences between those economies and the Indian economy.

Between 1990 and 2000 in Argentina external debt as a ratio of GDP rose from 44 per cent to 51 per cent. We are at less than 5 per cent of GDP. Those economies were mismanaged on all fronts leading to a serious financial crisis not just on one issue of external sovereign borrowing.

Any borrowing domestic or external should be done on the golden principle of deploying the resources so raised in the most fruitful manner to build infrastructure at the least cost.

If borrowings are squandered away on current consumption or not effectively and efficiently deployed and if corruption and inefficiency eat away the borrowed funds the economies are doomed to fail whether the borrowing is internal or external.

The greater concentration of the government should be on productive deployment of these funds and creating overall environment for private investment domestic as well as foreign. Fiscal discipline at the level of the central government by itself may not serve the purpose if the state governments are extravagant.

Proper mechanism should be worked out so that the states also adhere to the fiscal discipline along with the central government.

If the government is able to implement a blueprint for such a virtuous circle external sovereign borrowing may in fact turn out to be a boon. Meanwhile on an experimental basis limited external sovereign borrowing by government of India may be a welcome step.

Raghuram Rajan the former governor of RBI in his article cautioned only against possibility of such borrowings becoming addictive not against experimenting with it in a limited way.

(Writer is former Chief Secretary, Government of Andhra Pradesh)