An unexpected announcement in Finance Minister Nirmala Sitharaman’s Union budget speech was the proposal for the government to raise funds globally by borrowing abroad to bridge the deficit at home. It is not an idea one readily associates with a nationalistic political party like the Bharatiya Janata Party. The reason why since 1991 successive governments chose not to seek fueling growth through external borrowing was because of the terrible memory of what excessive and short-term borrowing in the 1980s did to India’s global standing.
While the PV Narasimha Rao government entered into a fiscal stabilisation and structural adjustment programme with the International Monetary Fund and the World Bank in 1991 to manage the balance of payments consequences of the fiscal and external economic policies of the 1980s, no government has since been willing to tap funds through external borrowing. Sitharaman’s proposal to launch sovereign bonds draws attention to the binding constraint on growth imposed by inadequate government finances and domestic savings. Resisting the temptation to print money and spend one’s way to growth, the finance minister has opted for incentivising private investment and borrowing abroad.
Taken along with the currency swap agreements signed last year with Japan and the United Arab Emirates, the Indian economy’s dependence on external finance is once again growing. With merchandise exports remaining sluggish, the finance minister has turned to import substitution in the name of Make in India. Partly to ward off criticism of protectionist trade policies from developed economies, the government has opened doors more widely to foreign direct investment.
If the government is able to stimulate new economic activity and thereby ease the domestic fiscal constraint, it will have more leg room to spur growth. However, this will have to be done with care, given increased exposure to global sentiments that comes with increased dependence on external finance and markets. In days to come, India will have to engage its global economic partners and financial markets to enable the finance minister to raise the funds required to finance higher growth. Equally, the commerce minister too will have to engage the world to justify the tariff measures announced in the budget. Managing both fronts will require deft diplomacy.
What could have prompted Prime Minister Narendra Modi to encourage Finance Minister Sitharaman to walk this path? It seems to me that Modi has concluded from his external engagements over the past few months that the global political environment is conducive to India’s increased external financial dependence even as it becomes more protectionist on the trade front. Incidentally, this stance is the exact opposite of the one adopted in 1991 when India chose to reduce external financial dependence while pursuing trade liberalisation.
In 1991 such trade liberalisation was facilitated by exchange rate depreciation. Today trade protectionism is being necessitated by exchange rate appreciation. Raising funds through dollar-denominated sovereign bonds will only continue to exert pressure against exchange rate depreciation. Managing the balance of payments with the trade account seeking depreciation and the capital account resisting it will be tricky.
What is interesting from a policy perspective is that Prime Minister Modi seems to believe that the external environment can in fact be more supportive of India’s growth aspirations even when the domestic environment remains challenging. This stance recalls to my mind a statement made by then Prime Minister Manmohan Singh at the India Today Conclave in February 2005: “I submit to you for your consideration”, he said, “the idea that the global environment has never been more conducive for India’s economic development than it is today. The world wants India to do well. However, we recognise that our real challenges are at home.”
Prime Minister Modi may well feel the same way today. He must, of course, be mindful of the fact that even if the global political environment may be equally conducive, the global economic environment is less so compared to 2005. Securing external support for India’s emerging strategy to become a US$5 trillion economy requires greater coordination between the managers of foreign policy and diplomacy, on the one hand, and financial and trade policies on the other. This, in essence, is the geo-economics of the budget.
Prime Minister Modi has an effective team of four persons in place, including Finance Minister Sitharaman, External Affairs Minister S Jaishankar and the ministers for industries and trade, Piyush Goyal and Hardeep Puri, to coordinate economic and foreign policy aimed at raising the rates of investment and growth and India’s share in world trade and capital flows. While Sitharaman and Goyal have a good grasp of the domestic economy and politics, Jaishankar and Puri are able diplomats with experience in economic diplomacy.
Such coordination between the managers of economic policy and of foreign policy has always been necessary but today it is more so both because of the many structural changes in global power and economic relations and the fact that this year’s budgetary strategy has increased the importance of external economic management to domestic economic performance. Of course, government spokespersons have quoted Deng Xiaoping to say that India will only “cross the river by feeling the stones.” That would be wise. But the stones to feel would be both economic and geopolitical.
It has been a long time since Indian macro-economic policy has exposed itself as much as it has this year to external judgments. Western rating agencies have lost some of their professional reputation but they have not gone away and sovereign borrowing will bring them back into play. Their considerations are never purely economic nor entirely professional. External debt brings with it exposure to external judgment. India’s nationalist leadership must learn to live with it. All the more reason why economic policy managers and foreign policy managers have to work in tandem to manage the geo-economics of fiscal policy.
The writer is Distinguished Fellow, Institute of Defence Studies & Analysis, India