Business Today|July 12, 2020
Every crisis has its victims, but common threads in sovereign defaults are high government debt, dependence on foreign capital and low foreign exchange reserves.
This time, too, a likely collapse of global economies post the Covid-19 outbreak will have its victims. The alarm bells are already ringing. Global rating agency Fitch has predicted record sovereign defaults in the current year.
Much before the Russian sovereign default in 1997, India had narrowly escaped a crisis in the early 90s when its foreign exchange reserves were enough to cover just a few days of imports. At present, however, foreign exchange reserves are at a much comfortable level of $500 billion, which can easily cover over 10 months of imports.
But, India’s vulnerability stems from growing government debt, both at central and state levels. “Growing debt creates refinancing risks. Debt management has generally veered towards fiscal restraint or responsibility. As you go ahead, fiscal dependence should drop and debt should become sustainable for refinancing,” says Chandan Sinha, Interim Director at RBI’s CAFRAL, an independent body set up by the central bank.
₹22 Lakh crore
Estimated borrowings of Centre and states in FY21 as against ₹13 lakh crore-plus in FY20
Consequences can be far reaching…
A sovereign rating downgrade — Moody’s has already downgraded India
Cascading impact on ratings of banks and corporate India
Increase in cost of overseas borrowings for companies
Risk for global institutions; lower capital allocation in Indian equities and debt
Higher interest outgo; constraints on annual budget expenditures
Crowding-out effect, corporate India to get less resources
Story so Far
In the early 90s, when reforms were initiated, government debt was at its peak at 77 per cent of gross domestic product (GDP). It, however, started falling soon. By 1996, it touched a low of 66 per cent and again rose to an all-time high of 83 per cent in FY04. Subsequent high growth (high denominator) partly resulted in fall to 66 per cent in the next decade. The ratio has remained largely range-bound at 66-68 per cent between 2011 and 2019. The question is, will there be a spike now?
India has entered the crisis with estimated GDP growth of 4 per cent in FY20. In an already slowing economy, which is expected to shrink further due to high fiscal deficit and higher budget expenditure, the debt-to-GDP ratio is expected to go up substantially. The estimates from domestic rating agencies suggest that the ratio will jump to 84 per cent in FY21. This means outstanding debt of ₹168 lakh crore, which is close to the GDP of ₹200 crore, assuming zero growth in the current year. The 84 per cent debt-to-GDP ratio will be the highest in the last two decades. Global rating agencies Moody’s and S&P have estimated debt figures of 83.7 per cent and 82.7 per cent, respectively, for FY22.
The implications for the economy are plenty — risk of a rating downgrade, cascading impact on ratings of banks and companies, and the danger of high inflation and currency depreciation. Eventually, banks and insurance companies will end up hosting this high government debt.
“It is a huge risk,” says a dealer who deals in government debt.
Any crisis that banks face will ultimately end up being a problem for the government since it has to safeguard the interests of depositors and their trust in the banking system.
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July 12, 2020