Fears are expressed constantly over India’s debt position (both internal and external). India seems to be gradually drifting towards a debt trap. According to the latest available data, the country’s total debt now stand at Rs 9,00,000 crore on external and internal account and the cost of servicing is about Rs 75,000 crore per annum which is close to the country’s revenue earning of Rs 1,00,000 crore every year.
The interest paid on the debt is likely to increase further in the near future as the Government has recently taken external loans at a high rate of interest. But at this moment, India’s debt position is much better than that in 1991. The percentage of debt had been reduced and was mostly long term which meant that India did not have to provide money immediately.
In India, internal debt had always been a problem. The World Economic Forum (WEF) in its meeting held in New Delhi on December 1995 has cautioned India of an internal debt trap accentuated by the increased pre-poll spending for the general elections, 1996.
In a scathing attack on the state and functioning of the Indian economy Mr. Claude Samjada, senior advisor to the WEF sounded an alarm that there was an urgent need to contain inflation, put a tight control over the increasing fiscal deficit, which if increased further would allow all economic calculations haywire.
The Government should also take right steps to control non-plan and revenue expenditure. He further said that it was not the external debt that was a cause for worry for India with the country’s external debt standing at $ 95 billion, but the real danger of the debt trap confronting India was on the internal front.
The steady increase of outstanding public sector debt was creating the gravest cause for concern as it was now reaching a very worrying 87 per cent of the GDP. Despite the fundamentals being good, the government had to dole out at least 70 per cent of its tax revenue for debt services which could go up to 75 per cent in the next two years, thereby reducing the centre’s ability to engage into productive investment.
In India, the per capita debt burden at the end of March 1996 was estimated at Rs 6,706. This is considered too high for a country like India, having a huge size of population. As long as the economy had a fiscal deficit, it was adding to the debt and it was the fiscal deficit that showed how much was being added to the debt each year.
This internal debt problem could only be solved by bringing fiscal deficit down and that was what the Central Government was trying to do. The Budget 2010-11 shows rise in fiscal deficit to 5.1 per cent of GDP.
Again India’s external debt was quite large and at the moment was the Eighth largest in the world. But India’s external debt should not be looked at in term of just its absolute size only. Recent estimates of external debt show that India’s external debt has increased from $ 83.8 billion during 1990-91 to $ 169.6 billion at the end of 2006-07.
Indian economy was the second largest in the developing world and thus, the fact that it had a large debt by itself did not mean anything. At this moment what one had to look at was the net debt service burden India was facing which the debt imposed on the economy’s payment capacity.
From this angle in particular, India’s debt service ratio, which was the ratio of the debt service payments to exports of goods and services had been coming up from a level of well above 30 per cent in 1991 to under 144 per cent in December 1999 but then declined to 4.8 per cent in 2007.
However, this ratio should be brought down further and the Government should try to reduce the amount of debt that the economy incurred so that the debt service ratio would come down to around 5 per cent by the end of 2010, which is considered a satisfactory level of such ratio.
Now turning back to foreign exchange reserves, which is an important indicator of economic strength of the country in its external front, shows a downward trend. The foreign exchange reserves, (including gold and SDRs) which have reached the level of $ 25.2 billion at the end of March 1995, declined by $ 4.89 billion, i.e. to $ 20.89 billion at the end of January, 1996.
However, the same reserve has increased to $ 309.16 billion in March 2008. And the foreign currency assets have also declined from $ 20.81 billion at the end of March 1995 to $ 16.32 billion at the end January 1996 and then it increased to $ 252.0 billion in March 2009.
Thus the import cover of the country by the foreign currency assets has also recently declined from 8.0 months in 1994-95 to 5.0 months in January 1996 and then it increased to 17.0 months at the end of 2008-2009. However, although India’s forex reserves stand at 252.0 billion dollar in 2008-09 but its external debt is pegged at 224.59 billion dollar.
Considering the problem, the RBI has now swung into action against exporters who are not repatriating their export earnings back to India. Though exporters are allowed to keep 30 per cent of their export proceeds in foreign currency, in view of the severe foreign exchange crisis, the RBI has now directed that all export proceeds should be repatriated.
Although the recent rupee depreciation against dollar has stabilized but panic reactions persist in the forex market. There is a rush for dollar purchase by importers in a bid to cover their respective forward positions and the market is still highly volatile.
Although the Government is maintaining that foreign exchange reserves position of the country is comfortable, it is, in fact not so. There is an apprehension that the position will further deteriorate in view of the strong current demand.
The fall in the dollar-rupee exchange rates from Rs 31.37 to Rs 35.90 can be attributed to the worsening current account position in BOP brought about by a deteriorating trade deficit, the fall in FII inflows, the shift in the Government’s debt servicing to the market, the pattern of corporate risk management mostly encouraged by the policy of RBI for providing support to the rupee in 1993 and 1994 and also the inflation differential.
In the mean time, the forces of liberalization brought about a considerable change in the factors that is responsible to determine the country’s current account. Abolition of the licensing regime provided sufficient impetus to the industry, which has resulted boost in the demand for their import of capital goods and raw materials.
With every other Indian firm started to borrow from overseas and going in for technological collaboration, the liabilities arising out of technical know how fees and royalty have increased considerably. Such increase in foreign exchange requirements was further abetted by phase-wise tariff reduction and phasing out of exchange control.
The worsening trade deficit in India would not be a problem as the forex reserves continued to grow. However, the long term outlook for the rupee still remains negative because of the fact that the country and its people are living beyond its means, the growing demand and import of POL is an indicator in this direction.
Living beyond the means is temporarily possible till that point as some-one is ready to finance such extravagance. Finance for meeting such extravagance would be available till that point as and when the overseas investor have their confidence in the credit worthiness of the country to repay its past debts. But such confidence is really a very fragile and flexible concept as the Mexican experience suggests.