• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

A. Seshan

While it is true that the prepayment of official external debt would raise the fiscal deficit, one has to consider the economic consequences. When the Government borrows foreign exchange from the central bank and remits it to its creditors, there is no effect on money supply. The RBI had earlier bought the forex from the market, releasing equivalent rupee resources and adding to the money supply. When the foreign exchange is released to the Government there is no withdrawal of the rupee from the economy. Thus it has a neutral effect on money supply.

THE country is sitting on $55 billion of forex. Ever since the Reserve Bank of India's external reserves started rising, it has been suggested that they be used to retire the high-cost external debt to the extent possible. The Government has permitted the private sector to do so depending on its foreign exchange earnings. Recently, the RBI Governor, Dr Bimal Jalan, made a similar suggestion.

Unfortunately, the proposal, to prepay part of the external debt, was reportedly rejected by the Finance Ministry. The reason is that the Government rupee borrowings from the RBI would widen the fiscal deficit. This is undesirable as the deficit is already projected at a high 5.7 per cent of GDP for 2002-03 compared with 5.1 per cent the previous year.

While it is true that the prepayment of official external debt would raise the fiscal deficit, one has to consider the economic consequences. When the Government borrows foreign exchange from the central bank and remits it to its creditors, there is no effect on money supply. The RBI had earlier bought the forex from the market, releasing equivalent rupee resources and adding to the money supply. When the foreign exchange is released to the Government there is no withdrawal of the rupee from the economy. Thus it has a neutral effect on money supply. True, Government's indebtedness to the central bank will go up. But it will only mean the substitution of official external debt by domestic public debt with no increase in total indebtedness. In terms of monetary aggregates, the fall in the net foreign exchange assets of the RBI will be compensated by a rise in the net RBI credit to Government. A rise in fiscal deficit per se is not to be objected to if there are no bad economic consequences.

There is also an advantage in the proposal. One can foresee only depreciation of the rupee in the near future. It will increase the real burden of external debt of the country, ceteris paribus. If domestic price rise is low, as it is now, the depreciation and the consequent rise in the rupee value of external debt would mean that the country has to export more real goods and services than before to service the same amount of debt. This disadvantage is absent if external debt is substituted by domestic debt.

According to the RBI's latest annual report, its total income in 2000-01 from interest, discount, exchange and commission from the external sector was Rs 10,086.08 crore (break-up not available). Thus around 47 per cent of the total investment income came from external sources in hard currency. This is welcome since the other part is derived mainly from manufacturing currency notes. The net rate of return on foreign currency assets and gold, after adjusting for capital gains/losses, is reported to be 5.8 per cent. While it is prima facie attractive it does not tell the whole story. One has to see how the reserves were raised. They were raised mainly through external borrowings of government and other parties, besides non-resident deposits in banks for which rupee resources were exchanged by the RBI. Export receipts have generally not been adequate to pay for imports The average interest paid on external borrowings must have been higher than 5.8 per cent considering that only 35.9 per cent of total external debt, as at end-March 2001, was on concessional terms from bilateral and multilateral agencies.

The investment income from abroad is an accounting illusion. While for balance-sheet purposes the RBI can legitimately claim this income, it should also, in future, present a true macroeconomic picture revealing the negative spread between the rates at which funds are raised and invested. From the nation's standpoint, interest paid and received on borrowings and investments, respectively, showed a negative balance indicating an outflow. It was Rs 17,414 crore or $3,821 million for 2000-01, as revealed by balance of payments data. The result of the prepayment of a part of external debt by Government would be a reduction in the investment income of RBI from foreign sources. But, from the country's point of view, there will be a gain considering the above. The interest income from Government would, no doubt, go up, but it would be paid back to it at the end of the accounting year by way of the remittance of the surplus of income over expenditure of the central bank. In a way the Government will have an advantage because the interest it pays to the RBI will return to it at the end of the year unlike in the case of external debt. For a presentation on fiscal deficit, the Government can have two sets of data — one including the effect of the prepayment of external debt and the other excluding it.

This will give a true picture of the impact of the transaction.

(The author is a former officer-in-charge of the Department of Economic Analysis and Policy, RBI.)

Send this article to Friends by E-Mail

Stories in this Section
Uncertain oil economy

Copyright © 2002, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line