Opinion | A note of caution on the issuance of sovereign bonds
4 min read . Updated: 05 Jul 2019, 11:22 PM ISTThe idea of borrowing directly from foreign investors is dangerous for many reasons
PRIVATE SECTOR INVESTMENT: Whatever the financial markets and pundits may say about its proposals, it was an undeniably proud moment to have a woman finance minister presenting the Union budget to the nation. This significance was not lost on the FM herself, whose speech devoted considerable space to dwelling on the role of women in the formal economy. She said that her government was committed to moving from launching merely women-centric schemes to women-led initiatives. India’s lower house of Parliament now has the highest number of women representatives, but women’s labour force participation rate is declining steeply. It is down by 10% in the last decade and half, and is barely 22% now. Some of this stems from the perverse effects of rising average household income (and relatedly, the increased opportunity cost of childcare), and from socioeconomic factors. But raising the participation of women in the paid-work economy is clearly a high priority for the FM and her government. One hopes that the labour-law reforms she mentioned include enough flexibility to allow greater participation of women. If women’s participation rates are on par with men, and if we have pay parity for similar work, then India’s gross domestic product can jump by nearly 20%. Of course. that’s not going to happen in the near term, but it is useful to keep this goal in mind. Even a rich country like Japan has gone all out in the past few years to increase the participation of women.
As for the overall macro context, the budget was against a backdrop of slow growth and stagnant private sector investment. Fiscal room for the stimulus of an expansionary policy was also very limited. We need to enter a virtuous cycle of fiscal consolidation, leading to lower interest rates and increased investment and savings, leading to higher growth. This indeed was the story behind India’s golden growth period of 2003-2008, as described last week in my column. But presently, the household financial savings of about 10% of GDP are almost completely pre-empted by government and public sector borrowings. Perhaps it is due to this tight fiscal situation that the FM mentioned the possibility of borrowing directly from foreign investors. This is a red line that India has never crossed, despite many temptations thrown in by foreign investment bankers. Even during the balance of payment crisis of 1991, or the taper-tantrum-induced panic of 2013, the government did not cave in. It pledged gold as collateral, or attracted dollar deposits by non-resident Indians, by sweetening the returns. We have even had dollar bonds floated by the State Bank of India to fend off the effects of the post-Pokhran sanctions. These bonds were seen as quasi-sovereign, but not quite what is being contemplated now. It is a dangerous idea for many reasons. First, it exposes the government’s liabilities to currency fluctuations, which can go wild. Second, it can affect domestic interest rates, much like offshore speculative rupee-dollar trading can adversely affect onshore volatility. Interest rate volatility is much worse than in currency. Third, and most importantly, it lets the government off the hook. If domestic fiscal manoeuvrability is tight, it affects interest rates because of the crowding-out phenomenon. But a market-linked price of government borrowing also acts as a disciplining device. If there is a safety valve, then the government just quietly borrows from foreigners in dollars, at a rate which is higher than what prevails in London or New York for sovereigns. Thus, the government incurs a higher cost through currency risk too. More worryingly, it may also cannibalize the foreign investment that is anyway coming in as foreign portfolio investment into domestic rupee-denominated government bonds. So, we hope that the FM thinks twice before floating dollar bonds. There are other ways to increase the pool of domestic savings—like, by selling (demat) gold bonds more aggressively, or giving higher incentives for contractual savings.
The overall fiscal deficit is capped at 3.3% of GDP, which signals a commitment to prudence. The super rich have to contribute a higher share, which is alright for progressivity, but one has to be cautious about not overdoing it. For instance, why is it that when more than 60% of GDP is now subject to the goods and services tax (GST), whose modal rate is 18%, the Centre’s share is barely 4% of GDP? This is not to make a case for a higher GST rate, but rather a lower one, perhaps with greater collection buoyancy. The fine print also showed dependence of nearly 10% of receipts from just two items: dividend from the Reserve Bank of India, and spectrum usage and other fees from the telecom sector. The latter is a golden goose, which is rather sick, and prefers to be spared any increased fiscal burden sharing. Rather, the telecom sector has accumulated unutilized GST credits of about ₹30,000 crore. The fiscal deficit is much larger than market borrowings because of increased reliance on small savings mobilization. No wonder the Indian bond market had a huge rally, but that is likely to be short-lived. You can only do so much of fiscal window dressing.
Overall, despite the fiscal constraints and limited options for a stimulus, the FM did very well in laying out a long-term vision of an economy that will run on the dynamism of startups, energized agriculture and publicly funded infrastructure of multidimensional connectivity. Add woman power to this, and the GDP target of $5 trillion might arrive sooner than most people think.
Ajit Ranade is an economist and a senior fellow at The Takshashila Institution
