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Raghuram Rajan raises red flag over a budget proposal

Raghuram Rajan

The recent Budget announcement by Finance Minister Niramala Sitharaman was a mixed bag. While it seemed to solely focus its attention on the BJP’s vote bank, the middle class, it was broadly thought that it didn’t do enough to encourage investment and spur demand that the economy so badly needed. A couple of announcements were also viewed as a deterrent for the stock market such as raising the effective tax rate to 42.74% on those earning in excess of ₹ 5 crore in a year, which discourages Foreign Portfolio Investors from participating. Further, raising the minimum threshold for public shareholding in listed companies from 25% to 35%, thereby making it mandatory for promoters to offload 10% of their shares in the open market.

A rather controversial proposal the FM seeks to implement in her maiden budget is issuing overseas bonds to facilitate borrowing by the government. The government from time to time is in need of money, and resorts to borrowings for this purpose. For example, the fiscal deficit target set by the government for this year is 3.3% of GDP. This means, the deficit or the difference between the government’s receipts and its expenditure is expected to be somewhere in the range of ₹ 7 lakh crore. This deficit has to be made up by borrowing money. There are two sources from which the government can borrow this amount, i.e. via the domestic route or from foreign borrowings.

It is precisely this, what the centre is seeking to implement with its new ambition of borrowing a larger portion of its requirement from the overseas market.

This proposal has come under severe criticism from various quarters including from former RBI Governor and esteemed economist Dr. Raghuram Rajan, who was quoted as saying, “this plan comes with several risks, but no real benefit”.

India has always been conservative with respect to overseas borrowings, only preferring to do so when absolutely required, and for minimal amounts. Now, however, with the government announcing its intention to fund 10% of its requirement through this route; a host of heavy hitters, which include the likes of former RBI Deputy Governor Rakesh Mohan, former head of the Planning Commission Montek Singh Ahluwalia, and most recently Mr. Raghuram Rajan, have joined the ranks in their criticism of this move.

Mr. Rajan, via a recent column in the Times of India, busted all myths about why taking on such overseas debt or external commercial borrowings is beneficial.

He wrote that primarily, the belief is that external borrowings are cheaper than domestic borrowings for the government, with interest rate difference being 3 to 4% less expensive. However, the fact is that because India has a high inflation rate, our currency keeps depreciating against the dollar or other major currencies; and hence any interest rate advantage is offset by the rupee depreciation when making principal and interest repayments.

He went on to say that another popular belief is that foreign inflow of capital is always desirable, and brings with it liquidity in the form of forex. But then, he goes on to say, is borrowing the best route to bring in such money? Why not instead relax the rules and encourage more foreign portfolio investors and bring in more funds through that route?

Also, by increasing our foreign debt, we are exposing ourselves to factors beyond our control, such as volatility in foreign markets. In regard to this, Mr. Rajan made a pertinent point when he said, “would the foreign tail wag the domestic dog?”

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