The second benefit lies in a positive externality imposed upon all firms that borrow abroad. A liquid yield curve for dollar-denominated bonds issued by the government and traded in London can potentially arise. If this comes about, then it constitutes a reference rate against which all Indian corporate borrowers will be priced. All Indian firms that may seek to borrow abroad would obtain better terms, as a consequence of the information production for the sovereign yield curve through active trading.
The third and most important issue lies in difficult times. Healthy public finance involves running a small primary surplus in most years. But once in a while, every country faces a calamity. It is in such times that a big surge in the primary deficit is called for, i.e. a large surge in borrowing. However, when India faces a calamity, it will be hard to raise money domestically. That is the perfect time to use foreign borrowing. Lenders abroad will be generally unaffected by the calamity faced in India, and will be the better source of lending compared to domestic lenders, who are themselves stressed when India faces a calamity. Establishing the ability to surge borrowing in an occasional calamity adds to the strategic depth of the Indian state.
These benefits come with two caveats. The first problem faced is the institutional arrangements for public debt management. At present, there is no unified view of the government’s strategy for borrowing, which is able to see the full picture, and make decisions about the currency composition of borrowing. There is no place in government that is able to understand what constitutes a liquid yield curve in London for Indian government bonds denominated in dollars and undertake the steps to establish this.
Illustration by Ajay Mohanty
What is required is a Public Debt Management Agency (PDMA), which would be the investment banker to serve the Ministry of Finance. This would take a unified view of all the borrowing of the government, and come up with optimal pathways.
Many observers have worried that borrowing abroad is a dangerous thing. It all depends on the magnitudes involved. In the present Indian situation, $25 billion borrowed abroad is about 1 per cent of GDP, and is not a threat but an important learning opportunity. But at the same time, the PDMA is required to keep track of the risks and manage them, particularly when bigger sums of money are taken from abroad.
The key idea required at the PDMA is a philosophy of building a long-term relationship with sceptical investors. We should have no illusions about what we’re up against. At present, almost all of the domestic government bonds are sold by force. Banks, insurance companies, the Employees’ Provident Fund Organisation, the National Pension Scheme, and now even mutual funds are forced to buy government bonds. The Indian state can make bad data and violate fiscal prudence, and there will be no consequences when faced with these forced lenders. In contrast, foreign investors are immune from coercion and have to be wooed. This requires a wholly different behaviour on the part of the Indian state.
This will require four tasks: Engaging with investors, answering difficult questions, improving the fiscal position, and improving data quality. When we fumble on one or more of these four problems, the cost of borrowing abroad will go up. Once voluntary lenders are in the fray, our self-interest will demand addressing these problems.
Nurturing a relationship with foreign investors is particularly important when it comes to the long-term objective of borrowing in times of a calamity. This requires first establishing the trust of regularly borrowing, and repaying on time. When this is done many times, India will earn the trust and respect of foreign investors. Advanced economies are able to easily borrow vast sums, at very low rates of interest, because they have a very long track record of borrowing and successfully repaying. The last time the UK defaulted on its debt was in 1688.
Building such a track record, well ahead of time, is required in order to obtain trust from bond investors when faced with a calamity. If the PDMA has a superficial engagement with foreign lenders, then they will shy away from lending to the Indian government when India has a calamity. If the PDMA builds a deep engagement with foreign lenders, where the Indian fiscal system elicits trust, then foreign lenders will offer enhanced resourcing to India when India faces a calamity, albeit at a higher interest rate.
To the extent that the Indian government learns how to engage with voluntary lenders overseas, this will be a valuable stepping-stone to changing course in domestic borrowing also, away from conscription of savings towards voluntary lending by private persons. Once again, the key insight is that substantially enhanced borrowing in a calamity can be obtained only from voluntary lenders, it cannot be obtained through conscription.
The writer is a professor at National Institute of Public Finance and Policy, New Delhi