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Developing countries usually do not possess sufficient capital resources to meet the economic and financial requirements of the country, which leads to the problem of resource gap i.e. the difference between resources available and the resources required to achieve the desired goals. As per the World Bank's Global Development Finance Report (2012), total external debt owed by developing countries increased by $437bn over 12 months to stand at $4tn at the end of 2010. It should also be noted that 40% of the total external debt stock is held by the BRIC countries such as Brazil, Russia, India, and China. To cover up its resource gap between expenditures and revenues, countries borrow from internal and external resources of funding. The most commonly used indicator to express and compare external debt is the Gross External Debt. In simple terms, it is the amount of a country's debt that was borrowed from foreign sources such as commercial banks, governments or financial institutions. 

Foreign borrowings are considered favorable as it provides additional resources to an economy that helps to achieve better economic growth. In the case of India, economic liberalization of 1991, allowed approval of foreign direct investment in many sectors. Total foreign investment in India grew from US$132 million in 1991–92 to $5.3 billion in 1995–96. Poverty reduced to 21.3% in 2016 from 46.1% in 1991 and the annual GDP growth rate reached about 7% from around 1.25 percent. It also helps to maintain a better fiscal and monetary discipline in the country as the government does not has any incentive to fluctuate the inflation level in order to reduce the debt burden. However, in the long run, there are certain disadvantages for high levels of external debt as it weakens the economy and makes it more vulnerable to the economic conditions of the foreign countries. For instance, the impact of Global Financial Crises of 2008 on the Indian economy was less severe because of the lower dependence of the economy on export markets and the major contribution to GDP was from domestic sources. However, the direct impact of the crisis was seen in the financial sector primarily through exposure to the financial assets, money linkages with the foreign exchange markets. 

India has a rising level of foreign debt as one of the major impediments to its development process. Government tries to maintain a lower level of the fiscal deficit through promoting foreign investment and disinvestment process. Achieving it becomes a challenge due to high subsidies on food and fertilizer provided by the government. On 1st February 2018, as proposed by Union Cabinet, a hike in minimum support prices for Kharif crops has been approved so that they are 50% higher than the cost of production, which is likely to inflate the food subsidy bill by over Rs. 15,000 crores. As per the reports of Reserve Bank of India, India’s external debt was $529 billion in March 2018, with 78.8% of total debt ($404.5 billion) owned by non-governmental parties such as private companies. Since end-March 2017, a 2.4 percent hike has been observed in total external debt; primarily due to commercial borrowings, short-term debt, and Non-Resident Indian (NRI) deposits.

India faces two major risks involved in external borrowing that is unexpected changes in the interest rates charged on these loans and an unexpected fall in the value of the rupee. Recently, the U.S. central bank is again expected to raise its interest rates two more times in this year, which has already been done twice before. Hike in the interest rates by the U.S. has already caused borrowing rates to rise in various developing countries, including in India. Another issue is related to decline in the value of rupee i.e. most of India’s foreign debt is contracted to the dollar. It means that the borrowers will have to pay back by converting rupees into dollars and if the value of rupee falls then the Indian borrowers will have to sell out more money than what they had estimated previously in order to repay the debt. The Indian rupee has fallen about 7.5% since the beginning of the year 2018, with last week falling to an all-time low of 69.09 against the U.S dollar; making it the worst performing currency in Asia.

The tightening of monetary policy by the U.S. has caused the price of American debt to fall and yields to rise. This step has pushed investors to pull money out of India in order to invest in the U.S., where they are more chances of getting a higher return. As per the statistics, foreign investors pulled out Rs.29,714 crores from India in May 2018 i.e. said to be the highest outflow since November 2016. This step will increase the outflow of capital and will lead to instability in the currency value and interest rate in the domestic economy. Apart for these, due to short supply of oil in the international market, Indian importers are competing to purchase more stocks of oil which have further accelerated the decline in the value of the Indian currency in the market. Thus, this will increase the rate of defaulters and eventually increase the risks of a systemic crisis.

Amidst these events taking place in the economy, there are likely chances of further soaring of external debt in the country to counter which on 6th June 2018 Reserve Bank of India (RBI), has risen the interest rate for the first time in four and a half years and is further likely to tighten the money supply in order to prevent further outflow of U.S. dollar. In this regard, it should be noted that unless a country grows fast enough to sustain debt obligations and maintains sufficient domestic investment, an indefinite cycle of external debt could have a very detrimental effect on the economy’s growth and overall welfare of the public.

   

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Image source: Zamora Cartoons

 

 

 

 

 

 

 

 

 

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Written By Surabhi Shree

Economics Graduate '18

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