A better way to keep local interest rates low is to raise FPI-limits in India, attract more FDI, or for the govt to simply spend less
Given how resource-constrained the government is, and the fact that higher government borrowing tends to raise interest rates—and, therefore, crowd out private sector borrowers—it is not surprising it is contemplating borrowing abroad; the fact that India’s foreign debt is low makes the move seem relatively risk-free. Last Thursday, the chief economic advisor had suggested India should tap the global markets because money was abundant and, therefore, cheap; and on Friday, the finance minister announced this in the Budget.
However, former RBI deputy governor Rakesh Mohan was quick to denounce the suggestion, saying it would be an imprudent and dangerous move. Forex markets are choppy, especially now, with US-China trade tensions so high, so any adverse movement can throw off all calculations and make overseas borrowing even more costly than that from local markets. To be sure, there will be good appetite for India bonds listed in London or even Luxembourg; after all, investors would be spared the exchange risk unlike in an investment made in India via the foreign portfolio investment (FPI) route. That is why, JPMorgan’s chief India economist Sajjid Chinoy said it could even cannibalise rupee-denominated FPI investments.
More important, a sovereign India bond means foreign investors will be in a position to influence interest rates in India in a manner similar to the offshore speculative rupee-dollar trading affecting onshore volatility. The volatility in interest rates can be worse than it is in currency trading, and the last thing we need is for investors to be indulging in arbitrage.
It is true that large levels of local borrowings could drive up interest rates and crowd out the private sector. But a market-determined price of government borrowing helps maintain some discipline; once the government has the option of borrowing abroad, this snaps the discipline and encourages the government to borrow more. Also, while the government may feel it is borrowing cheaper in New York, that may not necessarily be true once you factor in exchange rates. In which case, it may be better to simply raise the limit for FPI investments in the local bond market, both for gilts and corporate bonds. RBI could make the terms of investing somewhat more liberal; in the past, for instance, it has often insisted on residual maturities of, say, two years or three years—it could relax these if the forex situation is more comfortable.
Attracting more FPIs in the corporate bond segment, in particular, would help take care of the additional demand expected this year. It is not clear whether RBI has been sounded out and what it feels. The government may be hoping RBI would enter into some kind of forward transaction to ensure supply of dollars five or seven years down the line. The better way to tap foreign resources, if at all these are needed, is to attract NRI deposits without overpaying for them. The best option, of course, would be to ease FDI norms—for defence and other big sectors—and have an industry-friendly policy that will pull in sticky FDI, so that it is not vulnerable to fickle FPI flows.