Accessing foreign funds
After shelving the idea of issuing foreign currency sovereign bonds to fund the fiscal deficit, the government has now decided to issue specified categories of securities to non-resident investors. The idea behind the proposal mentioned in the 2020-21 Budget is to further open up the sovereign debt market for foreign investors and make sure that Indian government bonds figure in global indices. Inclusion in global indices would result in a stable flow of foreign savings. Some of the large and long-term investors such as pension funds invest on the basis of the composition of such indices.
The government’s intention to tap foreign savings is not very difficult to understand. According to the latest data, net household financial savings dropped to an eight-year low of 6.5 per cent of gross domestic product (GDP) in 2018-19. It is likely that household financial savings are at similar levels, which are not sufficient to fund the needs of both the government and the corporate sector. Total public sector borrowing itself is said to be at around 9 per cent of GDP. The decline in savings is putting upward pressure on interest rates, which is being reflected in the bond market. The flow of foreign savings would ease some pressure in the debt market and help encourage real investments. The government is also increasing the limit for foreign investment in the corporate debt market.
However, things will not be this easy and straightforward. There are wellgrounded reasons why policymakers in the past resisted opening up the debt market to foreign investors beyond a point. In the given context, it is likely that India will not immediately get included in bond indices and would need to offer a significant stock of bonds to foreign investors before being considered for addition in indices. Inclusion in such indices often depends on availability and liquidity. But large foreign inflows will put upward pressure on the rupee, which could affect India’s external competitiveness and increase the current account deficit. To avoid currency appreciation, the Reserve Bank of India will need to actively manage the currency, which could affect its monetary policy objectives. In fact, the Indian central bank had to make large interventions in 2019, which has resulted in surplus liquidity in the system at a time when inflation has gone above the upper end of the target band. Availability of foreign funds could also reduce bond market pressure in the short run and encourage the government to increase spending. This can pose financial stability risks in the medium to long term. The government is already running a fiscal deficit of well over 4 per cent of GDP, once the extra budgetary spending is added, and is mostly being used to fund consumption expenditure.
Thus, while the idea of inclusion in global bond indices and accessing global savings has merits at a theoretical level, policymakers should not ignore the fundamental weaknesses of the Indian economy. Some of the reasons such as the persistently high fiscal deficit and weaknesses in the financial system discouraged policymakers in the past from opening up the capital account. These weaknesses still exist. Therefore, it is important to first strengthen the fundamentals of the economy. Increasing dependence on foreign flows with weak fundamental could raise financial stability risks.