If debt is bad, taking new loans to pay back old ones has all the makings of a debt trap and the Indian government seems to be doing just that. India owed Rs 57,75,685 crores to internal and external lenders in the financial year 2014-2015 – a whopping 46% of the country’s gross domestic product. And it turns out that 77% of all long-term borrowings made by the government were actually used to pay back interest and principal on earlier borrowings rather than being spent on development expenditure.
Part of the reason for this is deficient forecasting and management of public debt, which is usually the responsibility of the Reserve Bank of India and the Ministry of Finance. Both these authorities have been considering ways to improve India's debt management and they seem to have finally found a way.
Last week, the government announced the setting up of a public debt management cell that will be converted into an independent authority in two years with a mandate to manage India’s public debt and forecast requirements well in advance and find ways to fund them at a desirable interest rate.
The Reserve Bank has been doing this job for the government so far in cooperation with the Department of Economic Affairs, and the results have not been great. Many believe the move to set up a public debt management cell will dilute the central bank's role in the country’s money management. But the idea behind it is something the Reserve Bank itself has pushed since 1997 through the Working Group on Separation of Debt Management from Monetary Management. And multiple committees, including the one headed by former Reserve Bank Governor Raghuram Rajan, have endorsed the view.
Ending conflict of interest
The formation of a new agency, experts said, would remove the alleged conflict of interest the Reserve Bank faces while deciding on monetary policy through interest rates and then making borrowing decisions for the government.
“There is a conflict of interest between the RBI being the debt manager and targeting inflation," said Radhika Pandey, an economist at the National Institute of Public Finance and Policy. "As a debt manager, the central bank would aim at lowering interest rates, but this would come in conflict with its inflation management mandate."
Rajan, however, said last year that the public debt management cell must remain equidistant from both the government and the Reserve Bank to actually remain independent.
“If that agency is too close to the government, then we should be careful… Government owns a number of entities in the economy today, public sector banks, LIC, etc, so that same conflict that existed in the RBI should not be transferred to an entity that has closer links with the government,” he was quoted as saying in the Hindu.
With the constitution of the new cell – which would be housed at the Reserve Bank's office in Delhi – the conflict of interest would be gradually removed. The government expects the cell to monitor its finances and arrange cash as and when needed through cheap interest rates and instruments such as government securities.
The formation of such a public debt management authority is also in line with the recommendation of the Comptroller and Auditor General, which in a report to Parliament in July had pointed out the dismal state of public finance management in the country.
As the chart above shows, India’s borrowings have continuously grown alongside its GDP over the last four years, but the percentage of public debt as percentage of GDP has risen marginally from 40.2% in 2011-'12 to 40.7% in 2014-'15. Moreover, much of this debt is internal as external debt and other liabilities together make up for a mere 11.6% of the government’s total liabilities.
The problem, however, lies in the fact that most of the short-term and a substantial part of the long-term borrowings are being used to service debt already taken, implying that little of the amount is left to spend on constructive development projects. For instance, India’s debt servicing liability for short-term borrowings was 101% of total receipts in borrowings in the year 2014-'15 while the corresponding figure for long-term borrowings was a high 77%.
The report of the Comptroller and Auditor General took note of this and said that debt servicing liabilities should not become larger as they undermine development expenditure, which is presumably the major reason behind government borrowings in the first place.
“In 2014-'15, 77% of long-term internal borrowings and 73% of external borrowings were utilised for debt servicing, implying that a larger percentage of debt was being used for debt servicing, which in turn meant lower percentage of debt taken was available for meeting development expenditure to promote growth, which is one of the reasons for contracting debt,” the report noted.
In its response to the government auditor, the Reserve Bank said it had been “discharging its functions effectively and efficiently".
A closer scrutiny of the numbers, however, casts doubts on this claim. For instance, the audit noted that expected cost of debt was not being projected forward efficiently and stress tests were not being conducted, both vital to ensuring the government has the ability to pay back its liabilities on time.
The Department of Economic Affairs, however, stated that most of the external debt was concessional and backed by bi/multi-lateral cooperation agreements between two or more countries. Hence, it did not bracket it under the category of “borrowings” – effectively excluding it from the government’s debt management strategy.
The Comptroller and Auditor General discovered that borrowings from the International Bank for Reconstruction and Development and the Asian Development Bank accounted for nearly 31% of total external borrowings by the end of the financial year 2015, and these were not on concessional terms.
“Further, whether concessional or not, [debt] is subject to exchange rate risk that needs to be managed through a well thought out strategy,” said the auditor.
The chart above shows how widely the government’s estimates and its actual borrowings varied in the last few years, ranging from a negative 33% to a positive 225%.
“Thus, it appeared that the system of preparation of budgeted estimates and revised estimates in respect of external debt was not robust,” said the auditor.
A similar trend was seen in forecasting estimates of the government’s cash needs. The Reserve Bank is tasked with forecasting weekly inflows and outflows in the government of India account, which needs to maintain a balance of Rs 100 crores on each reporting Friday. However, there were at least 40 weeks in each year when the variation between the projected cash balance and the actual cash balance was more than Rs 1,00,000 crores.
“The purpose of the forecast was to ascertain the possible position of cash so that appropriate steps could be taken to bridge the gap between projected cash management and projected cash availability, if any," the Comptroller and Auditor General said. “A wide variation between the projected and actual cash balance defeated the purpose of this projection.”
That is not all. The government should ideally have a robust internal monitoring system with near-real-time data of its borrowings and forecasts that are shared between the Reserve Bank and the finance ministry. But this is not the case. The auditor observed that E-Kuber, a platform used by the central bank for internal debt auctions, and the Integrated Computerised System, which it used to maintain various ledgers and registers, did not have any analytical functions as needed.
The Reserve Bank, in its reply, stated that it used Excel-based tools for its debt management strategy and the Department of Economic Affairs used spreadsheets too.
“The RBI stated that all data was available as a system of maintaining physical registers also existed in parallel and there was no risk of data loss, and [it] accepted that there might be issues with the report generation," the auditor said in its report.
All these deficiencies in the country's public debt management system led to huge cash outflows that could have been prevented. For instance, India paid more than Rs 600 crores in the last six years as commitment charges for withdrawing loans at a later date rather than the one it had earlier agreed upon.
“The need for payment of commitment charges points towards inadequate planning of loans/credits without proper linkages, with the requirement leading to avoidable payment of commitment charges,” the auditor noted.
With all that is going wrong with India's public debt management, the importance of a specific agency has become more pronounced, and economists hoped the government’s step to set up the public debt management cell would improve its financial condition and reduce the debt burden steadily.
“This move is timely as now the government has given the RBI the mandate to target inflation,” said Radhika Pandey of the National Institute of Public Finance and Policy. “The new cell would typically also require a liquid bond market so that it is able to raise finances for the government at the lowest cost. All this augurs well for the economy. This is not dilution of the RBI’s powers as the RBI will be able to focus on its core job of inflation targeting."