Debt Can Be A Virtue

The annual publication of the World Debt Tables has, for many years, been an occasion for moaning and groaning that India is the third largest debtor in the developing world, after Brazil and Mexico. But the latest edition of World Debt Tables shows that by the end of 1994, China\’s foreign debt had overtaken India\’s. Further, press reports indicate that during 1995, Indonesia\’s foreign debt has overtaken India\’s too.

Wait a minute. Isn\’t a large foreign debt supposed to be a burden, a sign of economic failure? All these years we have been told of an economic miracle in China and Indonesia. So how come these star performers are so deep in debt, even more so than India?

The best way to answer this question is to tell an old story about my mother, which merits repetition. My mother taught me that borrowing was a dreadful habit, which led to dissipation and bankruptcy. I assumed, naturally, that this must be true. Imagine my surprise, therefore, when I grew up and discovered that the biggest borrowers in the country were the Tatas and the Birlas. Their balance sheets mentioned debts of thousands of crores. Yet they were the richest in India. My mother, who never borrowed, died penniless.

The moral is that debt by itself is neither good nor bad, it all depends on what you do with the money. If you borrow for a spending spree, you will speedily go bust. But if you borrow to invest wisely, you can become very rich. The Tatas and the Birlas borrowed to build factories, and ended up with enormous wealth even after servicing their debts.

There are just two basic rules for successful foreign borrowing. First, the rate of return on your\’ investment must be higher than the rate of interest on your borrowing. Second, this remunerative return must be available in terms of foreign exchange, not just local currency. Provided you observe these two rules, borrowing ceases to be a vice and becomes a virtue.

If you can consistently borrow at IP per cent and get a return of say 15 per cent, you will soon become very rich. This is the experience of not just businessmen, but also of countries like Korea, Singapore and Taiwan, which borrowed large sums to finance their economic miracle. In the last century, the US economy was financed in considerable measure by borrowing from England. Australia became the richest country in the world based on foreign debt. So do not be surprised that China and Indonesia, two very successful countries, are also massive borrowers. They, like others before them, know how to make a virtue out of debt.

If you borrow at 10 per cent and get a rate of return of 2 per cent, you will go bust very soon. This fate has overtaken several countries in Africa. Despite massive debt reliefs and cancellations, Somalia\’s debt is still 3,000 times as high as its annual exports, Sudan\’s 2,000 times and Tanzania\’s 500 times as high.

If the interest rate on your debt rises, so must the return on your investment, otherwise you will go bust. This has been India\’s fate. Till the early 1980s, it got aid on such highly concessional terms that even low returns on investment were enough to service this debt. India could afford to be inefficient. Much aid came from the International Development Association (IDA), the soft, lending window of the World Bank, at just 0.75 per cent interest. In 1980, India\’s interest payments were $ 503 million on a debt of $ 20.5 billion, an effective interest rate of just 2.5 per cent.

However, the world became aid-weary by the early 1980s, and India increasingly had to borrow at commercial rates of interest. Since the money was inefficiently used, servicing this commercial debt became an increasing problem. In 1991, interest payments were $ 3.9 billion on a debt of$ 83.9 billion: the effective interest rate had nearly doubled to 4.6 per cent. This was still barely half the commercial rate. Yet so inefficiently was the money used that India went bust.

In 1991, India embarked on reforms aimed at making the economy more efficient. The reforms were half-baked, and so were their results. The private sector became more dynamic. But the public sector, which accounts for half the capital stock of the whole country, is now demoralised, under funded and suffering from a flight of good managers. Overall, efficiency has not improved much.

There lies great danger. Concessional aid is going to become ever more scarce, and may end altogether in five years. After that India will have to borrow entirely at commercial rates of interest, which are double the current effective rate. Given the long maturity of old soft loans to India, it will be many years before the effective interest rate on total debt doubles, but that will happen one day. It implies that in due course, India must double its efficiency of use too. That is a big challenge, but by no means insuperable. China and Indonesia have done it, and become rich in the process.

Unfortunately, it is far from clear that India will do so too. It has the capability, but not the proper political leadership. It needs a leadership that emphasises efficiency as never before. This is not in sight. So do not be surprised if, some years hence, we go bust again.

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