Most economic experts have spoken against the Modi government’s decision to borrow in dollars from abroad to fund domestic welfare and development. This is the first time that any government is resorting to the dollarisation of the fiscal deficit, on the ground that it will expand the government’s borrowing base and consequently enable the private sector also to borrow cheaper in the domestic market as the government’s share of borrowings partly shifts overseas.
The government – Centre, states and public sector companies – is by far the largest borrower in the domestic market and tends to squeeze out borrowings by the private sector. Just to illustrate this phenomenon with official data, the total household financial savings, constituted mostly by bank deposits and various other liquid saving schemes, are about 8% of GDP. The total borrowings by the Centre, states and PSUs are also about 8% of GDP. So the household financial savings are almost entirely appropriated by the government.
Of course, household savings have another component – in the form of physical assets such as real estate, gold etc. which are not strictly available in liquid form to be tapped by either the government or private sector for productive investment. This should constitute another 10% of GDP. So the total household savings are about 18% of GDP.
The real crisis which has developed over the past five years, forcing the government to borrow dollars from abroad, is that India’s domestic savings rate has fallen about four percentage points of GDP and almost all of it has been in household savings, which is the main source of incremental borrowing for the government and corporate sector. A decline in annual savings of 4% of GDP means roughly over Rs 7 lakh crore less of household savings available for investment every year.
Therefore, the government wants to tap the sovereign bond market to partially make up for the big fall in domestic savings. The big worry is that there is a structural decline India’s savings rate, and the Budget does not address this problem. Instead, it seeks to rely on the lazy and highly risky solution of dollar denominated borrowings.
From a political economy perspective, this is implicit admission by the Modi government that it has completely failed in achieving the most important objective of its biggest economic decision – demonetisation. Remember, Prime Minister Narendra Modi had repeatedly claimed that demonetisation has helped bring massive resources into the mainstream economy to help the government implement its big development plans. If this was indeed true, the next logical question to ask is why has India’s savings rate continued to stagnate three years after demonetisation.
We were told over Rs 15 lakh crore of cash came to be deposited with banks and a part of this also got invested in mutual funds eventually. And at last count, at least Rs 3.5 lakh crore of demonetised cash deposited with banks was being investigated by authorities for having evaded tax in the past. Then why have household financial savings not improved? This is a puzzle.
Again, as was stated by many economists at that time, cash was less than 2% of the total black wealth stock, the bulk of it being stored in real estate and gold. The government claims it is attacking real estate through the newly enacted benami law. But the results are abysmal so far.
Also, the government has hardly explored increasing domestic savings and investment by tapping the massive gold reserves with Indian households and private trusts. Sangh ideologues like S. Gurumurthy, now also on the Reserve Bank of India board, often boasted that gold lying with private entities should be more than enough to meet India’s investment needs. If that is so, why is the government taking the highly risky path of dollarising its fiscal deficit?
As per the World Gold Council data released some months ago, gold lying with Indian households and temple trusts is valued at 40% of our GDP. This roughly works out to $1,250 billion. About 15% of this – $185 billion worth of gold – lies with temple trusts alone. All of this is lying dormant and unproductive, and Modi had even explored bringing them into the productive stream via gold certificates bearing a nominal interest rate. I am told the idea got nixed on the grounds that it would hurt “Hindu sentiments”.
The government must use its immense political capital to overcome such emotional arguments and make a case for gold to be brought into the productive mainstream. Even 10% to 15% of the gold held with temple trusts will yield over $25 billion in new savings and investment. This is much more than we can possibly raise via sovereign borrowings which, as pointed out by Raghuram Rajan, are highly risky and susceptible to exchange rate volatility and the whims of global rating agencies.
There are many solutions still available to substantially raise domestic savings/investment and we must explore them first before rushing to do sovereign borrowings. More than anything else, this is the wrong time to raise dollar loans abroad as the world economy is facing an extraordinary storm in the form of the US-China trade war threatening to crash many big economies.
The global economy is slowing rapidly and India too is facing an unprecedented decline in consumption growth across sectors. Exports showed some uptick in recent months but again declined dramatically by 10% in June. India’s exports have been structurally stagnating over many years and a deepening US-China trade war will make things worse. China last week reported GDP numbers of 6.2% – a 27-year low.
Also, there is a big fear among economic analysts in the US that the recent phenomenon of 10 years US treasury yield falling below the three month US treasury rate is a predictor of recession. It has been argued that historically, the 10 year treasury yield falling below the short term rate in the US has invariably been followed by a recession. Normally, the economy’s good health in a highly liquid financial market such as that of the US, is reflected in the long term yield remaining above the short term yield. Any reversal of this is seen as presaging recession.
In such an uncertain economic climate, India wading into the stormy waters of global financial markets with a sovereign bond issue is ill-advised.