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India should use foreign money to fund infrastructure boom

Selling debt in dollars and yen has few risks and great advantages

| India
India will need a permanent public debt management office which decides on the currency mix of the country's overall borrowing.   © Reuters

One of the most controversial features of the Modi government's latest budget is the announcement that it would borrow in foreign currencies, such as U.S. dollar or Japanese yen, as well as the Indian rupee.

In the past, the government has pushed state-owned enterprises to take foreign currency loans to deal with balance of payment issues or for other reasons. But it has not taken any foreign debt on its own books, the only exception being borrowings from multilateral institutions such as the IMF and the World Bank. This budget, then, represents a clear structural shift in the policy.

With global interest rates at historical lows, the government's move makes sense given the pressure from investors and rating agencies to rein in its overall borrowing cost and contain its fiscal deficit to the budgeted level, 3.3% of GDP in 2019-20. The fiscal deficit was 3.4% in 2018-19.

Moreover, borrowing abroad also means less borrowing in domestic markets; borrowing at home tends to crowd out private investment by pushing up interest rates.

However, the announcement outraged many. Former deputy governor of the Reserve Bank of India Rakesh Mohan called it a "dangerous move." Two former RBI governors, YV Reddy and C Rangarajan, said it was unnecessary, and another -- Raghuram Rajan -- has said that the move has "no real benefit and enormous risks."

A prominent member of the Prime Minister's Economic Advisory Council, Rathin Roy, is also critical of the move, as is Swadeshi Jagaran Manch, an influential right-wing think tank. Economic affairs secretary S.C. Garg, the man behind the idea, has now been shifted out of the finance ministry, which has been asked to conduct a detailed study of sovereign bond issuance in light of these concerns.

The critics -- rightly -- say that sovereign borrowing in foreign currencies comes with exchange risks that India does not need to take. They argue that if the government wants more foreign money, it does not need to go for sovereign dollar or euro bonds, it can simply increase the limits on foreign investors so that they can invest more in the government's rupee bonds. That will lead to more foreign money inflows and involves no currency risk on the part of the government.

Exporters fear that an increase in foreign currency debt may prompt the appreciation of the rupee, which will dampen export prospects. Others who are opposed to the proposal remind that India shouldn't copy Latin American countries that have paid the price for embracing foreign currency-denominated sovereign debts.

However, despite the note of caution, the government's proposal is not without merits. Foreign investors are using more than three-quarters of their allowed investment in rupee bonds, so raising the limits will have limited impact, if any.

Besides, not all investors would be interested in taking the currency risk of investing in rupee bonds. There is therefore no guarantee this would increase flows when India's capital requirements are huge, given its large infrastructural deficit and social sector spending needs.

Exporters' fear is exaggerated as recent research shows that weaker rupee has a negligible impact on India's exports, which perform better when global growth is robust. And the comparison with Latin American nations is unnecessary, as their external debt-to-GDP ratio tends to be over 50% while their overall debt-to-GDP ratio is often as high as 100% or more. In case of India, these ratios are 20% and 68% respectively.

Moreover, India's sovereign debt denominated in foreign currencies was just 3.8% in 2018; China's is 14%. There is clearly enough room for New Delhi to increase its foreign currency denominated debt.

India needs an estimated $700 billion by 2022 to fix and upgrade its basic infrastructure; that money cannot be supplied by domestic savings alone, which are stagnating in any case.

Foreign currency debt will involve exchange risks for sure, but given the low inflation that is expected to continue and sufficient foreign exchange reserves, the extent of rupee depreciation should be lower than otherwise expected. Besides, part of the cost of hedging against currency risk would be met by saving on the coupon rates.

Global experience shows that most of the investment in capital intensive infrastructure development has to come from the government as it involves higher risks, lower returns and longer gestation periods. India's heavily indebted infrastructure companies are not in a position to commit large investments even though such investments will generate large externalities and hence are desirable.

The creation of world-class infrastructure has transformed the Chinese economy and made its businesses more efficient, productive and globally competitive. Given its global economic ambition and the current regime's focus on infrastructure, India should want to do something similar. India must tap global financial markets for this.

Economists expect direct borrowing by a sovereign like India, with a low level of foreign currency debt, to be cheaper even after the cost of hedging. As such, sovereign bonds would set the benchmark or reference rate for corporate borrowers looking to tap global financial markets for low-cost financing.

So far, the Indian government has "captive" buyers such as banks, state-owned insurance companies, the Employee Provident Fund Organization and National Pension Scheme for its sovereign debt papers. In this scenario, the government can ignore fiscal prudence without consequence.

In contrast, foreign investors cannot be coerced into buying Indian debt papers and need to be wooed. That will bring fiscal discipline on the part of Indian government so it can keep its cost of borrowing lower and, in turn, will encourage good macroeconomic management.

As any rise in inflation will push up the actual cost of the government's foreign currency debts by putting pressure on the rupee exchange rate, the government will be more committed to keep inflation low.

In the present situation, raising $25 billon-$50 billion -- less than 2% of India's gross domestic product -- will not be difficult. However, on a long-term basis, India will need a permanent public debt management office which can have the big picture in mind while deciding on the currency mix of the country's overall borrowing.

In addition to risk management, the key responsibility of this body will be to engage with actual and prospective foreign investors, answering their tough questions on India's economic fundamentals as well as advising the government on how best to raise finances.

Further, to minimize the risk of borrowing in foreign currencies, initially such debt should be raised in moderation and money so raised used productively, rather than for meeting revenue deficits.

If all this can be managed, going for foreign currency denominated debt is a risk that India should take up.

Ritesh Kumar Singh is chief economist of Indonomics Consulting and a former assistant director of the Finance Commission of India.

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