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The International Monetary Fund (IMF), in its recent Growth estimate revision, cut down the Global growth forecast by 0.1% to 3.2% for 2019, bringing it to the lowest level since the North Atlantic Financial Crisis of 2008. There was a major 30bps downward revision in the projections for India, even after the 20bps cut in the forecast of April’19. Incidentally, global growth concerns combined with aggravated protectionist trade policies and the likelihood of a no-deal Brexit are not the only hindrances that could impede a ‘precarious recovery’ next year. Gita Gopinath, Chief Economist at IMF, in her statement, mentioned how close to 70% of this improvement relies on an improvement in growth performance in stressed emerging markets and developing economies and is, therefore, subject to high uncertainty.

As for India, the recessionary air that has resurfaced can bring in major hindrance to the $5 trillion economy blueprint laid down in the recent budget, which requires the nation to annually grow by at least 14.2% to get there by 2022. Slowed auto sales and forecasts of lower than usual exports have already taken an effect on the market sentiments and demand in the economy. This year’s Economic Survey correctly identified that India must look up to its Asian contemporaries rather than the Anglo-Saxon nations for a more viable growth model. The Asian growth model has primarily relied on investment as the driving force of the ‘virtuous cycle’ that the economy represents, thus going by the classic case of boosting demand, jobs and income level by encouraging the people to finance productive activities. However, it is known by the Paradox of Thrift that there exists a trade-off between saving and consumption due to the fixed income level, which implies that funding investments solely from the savings of the domestic investors can deflate their consumption demand of goods and slow down economic activity. This creates the case for boosting foreign investment in the nation.

Until recently, the Foreign Institutional Investors (FIIs) had been an instrumental source of finance for the private sector. Now, the Indian government has chosen to step into the foreign markets by issuing sovereign government bonds, ordinarily denominated in INR, in terms of foreign currencies. Much has been said about the Indian government’s decision to take up this risk. The criticism drawn is primarily due to the absence of insulation from foreign currency risk, which can perhaps be retracted by the impact of low interest rates prevailing in those nations. So, if the government is borrowing from Japan in terms of Yen, simply because of the extremely low interest rates prevailing there, it is also contributing to generating demand for that currency which in turn will appreciate it. As a result, repaying the same amount in terms of Yen will require more of INR, thus robbing us of the advantages of the low interest rates. However, keeping all these apprehensions aside, the level of government debt will still take an impact through the crowding-out mechanism, which basically discusses the increase in the cost of market borrowings, i.e., interest rates, due to the increased borrowings of the government. The rising rates will evidently make it harder for the private sector to finance their operations since they are competing with the government for the economy’s savings. This eventually results in a decline in productivity. But that is not necessarily the case. If the government utilises the borrowed money as capital expenditure, it can contribute to boosting output much more than any revenue expenditure would, and in that scenario, the ‘crowding-in’ impact will take place. However, in the case of India, a mere 15% of the total borrowings is utilised for capital expenditure, while the rest is for revenue expenditure and studies reveal that the latter can be significantly cut down for good if only the government attempts to. Additionally, an increase in government borrowings does not only make loans expensive for the private sector but reduces access to debt, even for the ones who can presently afford it. This is because people expect the government to repay their additional borrowings by increasing corporate tax revenue, which in turn increases the risk of investing with the corporates, because of the possibility of reduced profitability.

The mere announcement of the issuance of G-secs in foreign currencies has resulted in a boom in the local bond market, and this has evidently made them a more profitable option for the local banks that must invest in them as a part of their SLR. Many invest over the prescribed limit of 20% of time deposits, which naturally reduces the room to accommodate private sector loans. And while the local banks are the largest channel of crowding out in terms of magnitude, the decision to raise funds from foreign markets also reduces the share of the private sector in the foreign investment pie, because the government bonds are the safer option and will be preferred in these times of volatility. In such scenarios, the large corporations can afford to issue bonds, but it is the MSME sector, which suffers, for it can neither issue bonds, nor afford the high local rates. At present, the credit gap (the gap between the demand for loans and the supply) in the MSME sectors is about 16.66 lakh crore rupees and over the past few years, it has risen significantly.

In terms of its effects on financial stability, the lack of access to debt leaves many companies no choice but to rely on short term debts for capital investments that have an extremely long gestational period, which in turn produces an increased risk of delinquency. A similar case was witnessed last year when the lack of ability or willingness of IL&FS to raise long term loans caused a near-crisis in the Indian markets. This creates the need for not only reconsidering the issuance of these sovereign bonds but also redesigning the composition of the government expenditure, which can be done by eliminating the unnecessary revenue expenditures to gain full advantage of the possibility of crowding-in of income. Although there are no confirmed reports yet, it is said that the government has applied breaks on the former after being besieged by criticism, but the latter is an issue that requires great attention, for productive investment will be the lifeblood of the $5 trillion vision.

By Riya Kaul


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