Illustration by Ajay Mohanty
There is no doubt the finance ministry will be worried about the size of the national debt relative to GDP that India will run up in doling out support to different segments of the economy. It is not a worry about growth slump or the phrase “secular stagnation” made famous by former US treasury secretary, Larry Summers. It is about “expecting the emerging markets to copy mechanically what the developed economies can do”, as Sajjid Chinoy perceptibly commented at an NCAER event, in April last week.
The ministry has reasons to be worried since this metric has, of late, often become the measuring rod for rating agencies and for the global debt market to decide how much to invest in a country. While the government seems to have again woken up to the need to pull investments from abroad, a ratings downgrade would be unwelcome news.
It has been a tricky terrain though. The troika of S&P, Moody’s and Fitch is far more strict about measuring the health of the emerging markets than about developed economies. Notice that Singapore, despite the lockdown extension, has retained its triple-AAA rating. India’s, on the other hand, is just a notch above junk. The Narendra Modi-led government has already imposed barriers on foreign investment from China, directly and indirectly. The alternative, investments from the sovereign wealth funds of the Middle East, does remain but with a big if, once the ratings dip. Though the oil funds (about $3 trillion) badly need some performing assets to make up for the disasters in most sectors globally and India could be the answer.
Despite the concerns, is India making too much of a big deal over the debt-GDP ratio? Unlike individuals or companies, an economy can survive ballooning debt though in the very long term it loses its ability to service borrowings. A government runs up a debt when it borrows to finance itself. The national accounts adds up all these borrowings, including those by provincial governments, to estimate the size of the sovereign debt. For India, a Fitch Ratings report estimates it at close to 70 per cent, higher than comparable economies. The more a government borrows, the higher it has to push up interest rates to keep the markets interested. India has a lovely cushion in that most of its debt is held domestically. So even if the debt does rise by, say, Rs 5 trillion—the projected size of the economic stimulus over this year—yet the relative share of the domestic to foreign market remains, should it still be too much of a concern.
Paradoxically, it could be since firms and individuals too will also borrow big time to survive past the pandemic. Leverage will rise as operating revenue will be down 10 per cent for companies across the board, notes a Crisil report. While rates would ordinarily need to rise to make people lend to governments, firms and individuals would want the rates to come down to borrow more for themselves. As Martin Wolf points out in this column for FT, as debt soars “people are ever more unwilling to borrow still larger amounts”. What happens then?
Interest rates have to keep on sliding to make them borrow, bringing the rates to even zero, according to Summer’s secular stagnation hypothesis. But as we have seen, governments of emerging market economies cannot let the rates slide if they have to raise large capital from abroad. So large debts by the states do matter.
Certainly, while it is one thing for the US Fed not to offer an interest on the dollar, investors will not buy the same argument for the Indian rupee. Interest rates have to be positive for money from anywhere to come in. Chinoy says since markets like India do not have reserve currencies, the debt overhang could make capital move out. “Fiscal polices too have to be exceptionally intelligent in the circumstances,” he says. The shock for the Indian economy has been larger than most (because of the low per capita income and a far larger population), but the concern with the debt-GDP ratio means it is fashioning a response with one hand immobile.
But is this risk immediately on the horizon? The overwhelming attention to debt by rating agencies might be exaggerated. Every key economy is raising their debt big time. The average debt to GDP of G7 economies was above 260 per cent by 2017. It shows no sign of coming down. India, with a close to $3 trillion economy before the pandemic, had a central government debt of only 50.3 per cent of GDP in FY19. It is the pace of the economic recovery from the pandemic with all sectors intact that will interest the investors from abroad. For instance, to make banks and NBFCs lend to the MSME sector, economists like Abheek Barua of HDFC recommend a “backstop to banks which will help”. It will mean giving up the concerns on debt. "The low current account deficit gives room for policy space," he says. The foreign flows will weaken but not too badly, he reckons.
Essentially India has to chance it. And then as Chinoy says, run an exceptionally intelligent fiscal policy, with it.