The other debt

Trend in external debt numbers needs watching

India’s external debt, as per half yearly balance of payments statistics released by the finance ministry, was $296 billion, a year-on-year increase of 13 per cent. While long-term debt increased by 9.5 per cent to $230 billion, short-term debt registered a sharp increase of 26 per cent to $66 billion. The total external debt increased by an absolute amount of $33.5 billion, of which $6.3 billion (roughly 19 per cent) could be ascribed to a “valuation effect” arising due to the depreciation of the dollar against other major international currencies. The impact of dollar devaluation on India has expectedly been sharp, given that over half of India’s external debt is dollar denominated. External Commercial Borrowings (ECBs), mainly by the Indian corporate sector seeking to benefit from the arbitrage between domestic and international interest rates, are an important reason for the rapidly increasing external debt. The share of ECBs in total external debt stood at 28 per cent, followed by non-resident Indian deposits (17 per cent) and multilateral debt (16 per cent).

It is the sharp increase in short-term debt that is a cause for some concern, especially with the current account deficit approaching 4 per cent of GDP. While short-term debt is admittedly only 22 per cent of the total debt, it is the sharp increase and the reasons underlying it that need to be studied carefully. This particularly applies to ECBs which are often speculative in nature. It makes sense for Indian corporates to finance their expansion plans by borrowing abroad at a lower rate of interest, but indiscriminate borrowing with the idea of making a quick buck needs to be discouraged. The current account deficit at around 4 per cent of GDP is unacceptably high. Indeed, if it has not completely gone out of hand, India’s relatively low oil prices and remittances from non-resident Indians ought to be thanked. The anomalies in trade have also worked to India’s advantage thus far: despite a steadily appreciating rupee, exports have increased, while import growth has been tepid. While export growth will hopefully continue unabated, thanks to a variety of government incentives and the increasing competitiveness of Indian exporters, imports will also increase once industrial activity regains its pre-crisis momentum. India can ill-afford a further increase in the current account deficit caused by reckless behaviour.

India’s foreign exchange reserves of $295 billion ensure that a repayment crisis reminiscent of what happened in 1991 is unlikely. A sharp increase in debt might force the Reserve Bank of India to increase its reserve holdings more than necessary, as a purely defensive measure. This, in turn, would entail a humongous cost by way of payouts on bonds as part of a “sterilisation” strategy that RBI would have to follow to prevent the rupee from appreciating. The untrammelled flow of foreign capital into India during 2004-07 left RBI with few options and is certainly a situation it hopes would not recur. But the government and RBI should be prepared for such an embarrassment of riches if India remains an attractive destination for global capital flows.