Risky business

The government's proposal to borrow from foreigners could be dangerous if not properly handled

The finance ministry is looking for ways to borrow from foreigners. It may be better for the government to borrow from foreigners, who cannot be arm-twisted, rather than borrowing in India, where banks are forced to borrow from the government. The four key principles to be used to guide foreign borrowing are as follows: getting debt management out of the RBI; emphasising foreign investment in India rather than issuance abroad; establishing a clear target as a ratio of GDP for the stock of borrowing from foreigners; and building the high-quality institutional capability required to engage with global bond investors. Such borrowing can be dangerous when it is denominated in dollars, but not when it is denominated in rupees.

As The Financial Express reported on April 4, the finance ministry envisages movement towards foreign borrowing. This can be seen in the Union budget tabled earlier this month. Para 42 of the Fiscal Policy Strategy Statement, tabled along with the budget by Pranab Mukherjee, the finance minister, in Parliament on March 16, says that the government can explore selling its bonds abroad: "With a gradual decline in net inflow from multilateral institutions in the coming years, the government would have the option of exploring other sources of external debt in the form of sovereign bond issuance".

Traditional economists usually have a fear of foreign borrowing. In India's case, the rationale for opening up the capital account to private flows was to move away from official flows. Foreign borrowing by emerging economy governments was, at the time, possible only in dollars, and was thus associated with dollar debt. But today, emerging economy local currency debt is feasible. The currency in which borrowing is done matters greatly. Borrowing in foreign currency denominated loans is dangerous, because repayment becomes harder in the event of a big depreciation. When $10 billion has been borrowed and the exchange rate is Rs 50 to the dollar, the repayment of principal is Rs 500 billion. But if the rupee were to depreciate to Rs 75 to the dollar, the repayment would swell up to Rs 750 billion.

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