India’s Overseas Debt Plan May Leave it Vulnerable to Future Shocks 

The key worry, especially for the RBI, is that an emphasis on finance capital and hot money leaves us with fewer options to navigate the next global crisis.

One key lesson to be drawn from the financial crises of the 20th and 21st centuries is how economies, despite being aware of the cyclical nature of crisis-causing factors, continue to go from one problem to the other without learning from their own histories. 

Argentina’s own financial history, over the last 30-40 years, tells us how its economy struggled to avoid getting trapped in a debt spiral again and again. 

Added to this is that most countries believe that economic crises probably happen to ‘other’ economies and not them.

All of this should be kept in mind when examining the finance minister’s recent budget announcement that India would start borrowing externally in foreign currencies to meet requirements for domestic capital needs. The decision to use borrowed capital to meet the growing needs of domestic public borrowing requirements can expose India’s less-than-pristine macroeconomic fundamentals to a highly-levered, liquidity-crunched global debt market. 

A critical question to ask here is: how, or in what form, will one see the next global financial recession appear? And how well prepared are we? 

The short, and direct answer to the second question is: We aren’t.   

For the first question, a closer look at the highly volatile nature of US equity and global commodity markets today, amidst America’s rising trade tensions with China, India and countries like Iran, where a full-blown political escalation from Trump could trigger an oil shock situation in the US and crash the dollar’s value. Each of these issues indicates high degrees of financial vulnerability for each of the economies that are either borrowing excessively in dollar-pegged bonds or in other foreign currency-based assets as a short-term fix for tackling their own ‘liquidity concerns’. 

The dollar’s value has remained quite volatile in recent quarters and this is likely to be the case for some time ahead, seeing how the Federal Reserve, under Jeremy Powell – a supporter of Trump’s hyper-nationalism – is likely to steer the US monetary policy.  

Global growth trends have also appeared to become more stagflationary in nature, i.e. seeing low growth with rising inflation, if observed from the current conditions of growth in China, India, Brazil and the emerging markets space. Furthermore, growing uncertainties from trade tensions and spikes in oil prices can impose serious supply-side shocks in each of these emerging markets, threatening the growth of aggregate demand and simultaneously weakening consumption demand too (as higher tariffs and fuel prices lower disposable income of citizens). This is already showing effects in India where consumption demand of the top 10% income earners has weakened in recent quarters.

Also read | India’s Overseas Debt Plan Has Limited Benefit And Many Risks: Raghuram Rajan

The 2008 financial crisis had features of a ballooning borrowing scenario (within the US credit markets), amidst blinding complex nets of mortgage-backed securities, and with derivative tricks used to prop-up asset prices. The quantitative easing policy response from the Fed and Treasury might have worked then to address the immediate fallout of the banking crisis. 

However, the structural opaqueness of global financial markets, as observed then, remains dangerously higher even now. At the same time, underlying debt (or leverage) for the public and private sector in most emerging and advanced economies remains higher than what it was in the pre-2008 context. 

One reason for this is the growing rise of ‘finance capital’ – as a means of increasing capital needs – within emerging economies facing a ‘populist’ drive. Similar instances were seen in the past in Latin American economies like Mexico (in the early 1990s), Brazil, Argentina and Chile (during 1980s), when freer capital mobility pushed these nations to accumulate more finance capital and fewer sources of industrial and commercial capital. Similarly, a quest for such quickened means of capital – especially through external borrowings in dollar-pegged assets – might change the usual form of ‘capital’ that has otherwise been accumulated for driving growth in India. 

Capital, in its most effective form, can best be utilised for growth if it is accumulated in the form of industrial or commercial capital, which boosts investment cycles for higher growth performance. ‘Finance capital’ which often acts more like “a personal link-up, between banks and the biggest commercial and industrial houses” can aggregate crises of higher magnitudes as seen in countries within Latin America and Southeast Asia in the 1990s. 

Lenin, in Imperialism-The Highest Stage of Capitalism, defined how an explicit role of ‘finance capital’ – with its appearance into the economy –can end up playing a rather more ‘hegemonic’ role in shaping imperialist tendencies, where “a handful of monopolists use it to subordinate to their will all the operations, both commercial and industrial, of the capitalist society” before crisis strikes.  

From a crisis-management perspective, what’s troubling is how limited the tool-kits are for addressing a crisis that is triggered from spells of commodity price shocks or from a crashing dollar when finance money gets too ‘hot’ to handle. 

Also read | Why India’s Plan to Launch a Sovereign Bond Should Be Viewed with Ample Caution

In 2008, all private or public-owned financial debt ultimately became the government’s own responsibility to pay for (as seen in other bailout situations too). And in the US, while it had (and still has) the luxury of printing dollars to use it for capital injection (which serves as its domestic and the global reserve currency) to ensure solvency for troubled banks (or indebted entities), others may lack such a ‘monetising approach’ to get out of a crisis. 

For emerging countries like India, a relatively weak and volatile domestic currency makes them most vulnerable to capital borrowings made in form of dollar-assets. At the same time, the central bank (seen as a lender of last resort) has very limited options to help them navigate out of a crisis-scenario if the accumulated debt is in dollars and not in rupee itself. This is precisely why most members of the RBI (including ex-RBI governors like Raghuram Rajan) remain so sceptical on the finance ministry’s current decision to borrow in dollar-denominated assets. A good strategy to increase external borrowing capacity – as practiced under Rajan’s tenure – is to ‘popularise’ the demand for Indian currency-based (pegged) assets through Rupee Masala bonds in international markets. This may take time but will give more tools to the RBI if a global recession strikes. 

The domination of finance capital – as ‘hot’ money, which gives investors the option to pull out money as they please – caused the 1929 crisis (where a stock market crash triggered the Depression), and was predominantly seen as the main floating capital during the World War periods, European civil wars, and in the post-Bretton Woods era (when exchange rates shifted from a fixed parity to flexible forms). 

Raghuram Rajan and Luigi Zingales in their book, Saving Capitalism from the Capitalists, discuss these aspects in great detail, drawing examples from Latin American economies like Mexico and Argentina. 

While a growing short-term need for foreign investment or credit to be utilised for domestic capital needs remains part of a standard short-term policy fix these days, especially for emerging nations where domestic savings-investment ratios are low, it’s vital to understand how any overt macroeconomic dependence on portfolio-based debt borrowings makes India susceptible to a self-fulfilling crisis. 

While India has otherwise been cautious in being more macro-prudent since it liberalised in 1991, seeing industrial and commercial capital as the main requirements for maintaining higher growth rates should be the step forward even now. Unfortunately, this might be changing now, making India most vulnerable when the global recession strikes.   

Deepanshu Mohan is an associate professor and director, Centre for New Economics Studies at O.P. Jindal University. He is a visiting professor to the Department of Economics, Carleton University, Canada.