India’s current account deficit was a record 6.7% of GDP in the last quarter of 2012. The deficit was plugged mainly by foreign direct investment, foreign portfolio investment and NRI bank deposits. But a significant, rising contribution also came from foreign borrowing, by corporations and the government.
Total foreign debt is now estimated at almost $400 billion. This is much higher than our foreign exchange reserves of $280 billion. Interest payments on foreign debt have quadrupled from $5 billion to $20 billion in the last five years, and this is alittle-noticed reason for the widening current account deficit.
This raises an important question. Has foreign borrowing gone dangerously high? Should the government press the brakes?
Why Beg or Steal
No, not at all. Rather, there is a strong case for a borrowing spree. Never before have interest rates been so low, and India’s access to global financial markets remains good. In 1998, hit by the Asian financial crisis and US sanctions after Pokhran-II, India raised $4.2 billion through India Resurgent Bonds at 7.75% interest, with a five-year maturity. The interest was tax-free, making it equivalent to a rate of 11% taxable. Then, in 2000, $5.2 billion was raised through India Millennium Deposits at 8.5% interest for five years, equivalent to almost 13% in taxable terms. These were very high rates of interest.
By contrast, the State Bank of India has recently raised dollar bonds at just 2.25% above the US Treasury rate, equal to just 3.25%. That is a floating rate, and a fixed rate would be costlier, but not by much. US 30-year fixed-interest mortgages now carry just 3.5% interest. That shows how cheap long-term money has become. There has never been a better time to borrow from abroad.
The US is having a third round of quantitative easing, and the Fed is deliberately targeting long-maturity bonds to keep long-term rates low. This greatly increases the case for long-term borrowing by India too, to take advantage of cheap rates. The eurozone has always had low rates, and these have just got lower with ECB action. Japan has gone on a new quantitative easing spree under Premier Shinzo Abe.
For the first time, Japan actually aims to double the inflation rate from 1% to 2%. In the US and Europe too, inflation has remained astonishingly low for years despite huge amounts of monetary expansion, but one day, this mountain of expansion will stoke high inflation.
At that point of time, borrowers will be rewarded with a huge erosion of the real value of their debt. So, borrowers today can look forward to the double advantage of low current rates of interest, plus an erosion of debt value by coming inflation. It is an opportunity not to be missed.
India plans to spend a trillion dollars in the next five years on infrastructure, of which at least half is to come from the private sector. This will not happen without streamlined procedures for environmental, forest and tribal clearances.
Even if that happens, where will a trillion dollars come from? Infrastructure projects are often done on a high debt-equity ratio of 3:1 or 4:1. But Indian banks already have an uncomfortably large exposure to infrastructure, and find it imprudent to lend more to this sector.
Psst… Trillion Going Cheap
Unquestionably, a lot of the money will have to come from borrowing abroad. The Japanese government will help out with the two rail corridors and the World Bank is ready to expand its lending.
But even these efforts will pale before the target of $1 trillion. Massive external borrowing for infrastructure is unavoidable. Very luckily, the money is available today on bargain basement terms.
Apart from the SBI, Reliance Industries, Bharti Airtel, ICICI Bank, HDFC Bank, Exim Bank, PowerGrid, Tata Communications and others have raised a whopping $7.5 billion in the first four months of 2013, three-quarters of what India Inc mopped in the entire previous year.
Some see danger in this. But the corporates themselves are very happy to be able to raise so much money so cheaply, in nominal and real terms. Even if they swap dollar loans into rupees loans, their net cost is barely 6% in rupee terms.
Till now, the government has refrained from a sovereign bond issue. Yet, there is a good case for a series of such bond issues, totalling maybe $100 billion.
All borrowing carries risks, which need to be guarded against. Bond issues should be spaced to avoid bunched repayment in any one year. Maturities should be lengthened, to 20 years if possible. In the Asian financial crisis, Thai banks borrowed abroad cheaply to lend at higher rates for local real estate, and that sort of blunder must not be allowed by the RBI. Large exporters have an inbuilt forex hedge, and so can be the most liberal in borrowing abroad.
Provided sensible precautions of this sort are taken, massive external borrowing will be sustainable for several years, until global inflation and interest rates start to rise.