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Economy
Sovereign Debt
Don’t worry about the debt situation in India. In view of the long-drawn sovereign
debt crisis issue globally, we take a look at how India is positioned in the whole scheme
of things. India is comfortably placed, thanks to the healthy nominal GDP growth and
the way debt is held in India. Though borrowings have been high for the past few
years, the stability of the debt/GDP ratio is not an issue. Also, most of the debt is held
internally which reduces the interest rate risk to the economy.
Downgrade of sovereign debt would not be justified
The central government debt is around 45% of GDP which is within the limits prescribed by the
13th Finance Commission. Consolidated debt is around 72% as of FY2010 which is slightly higher
when compared to its peers in the EM space. However, the situation does not look risky for India
as most of the debt is internally held and financial institutions like banks and insurance companies
have to (by regulation) keep part of their NDTL/investments in government securities. This creates a
captive for government. Along with this the majority of the debt is internal debt thus insulating
the country from any foreign exchange risk. External debt is not only low at 9.75% of total public
debt as of June 2011, most of it is in the form of debt from the bilateral and multilateral agencies
where the rates of interest are on the relatively lower side.
Large market borrowings unlikely to danger debt sustainability
We apply the rule-of-thumb to assess the stability of the public debt in India. Two main metrics
that we use are comparisons between (1) growth rates of debt and nominal GDP and (2) nominal
GDP growth and average interest rate for interest payments. On both the metrics, we find that
barring the period from FY2000-FY2003, nominal growth rate has remained above the growth in
debt and also the average interest rate on interest payments. Hence stability is not an issue with
public debt. Even though the gross debt/GDP ratio for India is not too high (compared to the other
countries which are in crisis), still we check for a stricter test in terms of primary balance to interest
payments. Theoretically, if a country has high debt/GDP ratio (even if stability is not an issue) then
for debt to be sustainable it needs to have a primary surplus on the fiscal to comfortably meet
interest payments. India has not been in surplus for more than a decade now, yet the primary
deficit/interest payment ratio has improved till around FY2007. It deteriorated again owing to
expenditures on the farm loan waiver scheme, the sixth pay commission and fiscal measures to
support the economy during recent crisis. The trend has reversed since FY2011. We continue to
stress that a consolidation on the fiscal side would be needed in order to remove risks to debt
sustainability.
The debt/GDP trajectory does not worsen significantly in our stress-test scenarios
We look at 3 scenarios (1) interest rates for interest payments at 9%, (2) real GDP growth at 6.5%
and (3) a combination of both. Against our base-case scenario which projects debt/GDP at 62% in
FY2020E, we see debt/GDP increasing to around 72-74% with a combined effect of higher
interest rates and slower growth. However, we do not see much risk to stability of debt/GDP in the
medium-long run. Likely boost from reforms in taxation and rationalization of expenditure,
especially on subsidy front, will further lower the debt/GDP ratio.
Little rationale for any talk of debt rating downgrade for India
For India, concerns have been significantly raised time and again on the fiscal sustainability.
While the fiscal deficit had corrected by FY2008, it again increased sharply in FY2009 on
account of the farm loan waiver and the 6th Pay Commission awards. To complicate the issue,
the global meltdown post Lehman led to the Indian government also putting in further
accommodation in place by excise tax and service tax cuts. While some of this has been
reversed, we are still not back to the pre-crisis days, indicating that fiscal accommodation in
India continues. Unfortunately, for India, fiscal consolidation has been attempted through
reduction in the capital expenditures of the government while social sector expenditures
have continued to balloon over the years.
Exhibit 1 clearly indicates that there has been a sharp rise in the borrowings of the central
government over the years that have led to some sort of stickiness with regards to the
interest rate at which the government borrows. Further, Exhibit 2 indicates that the amount
of interest payments has increased sharply and the total wasteful expenditures in the form
of interest payments and subsidies account for more than 50% of revenue receipts. In the
final assessment, the constraint to correction in the fiscal deficit in India is mainly due to
structural impediments. Even when growth rates rise, the cyclical components remain
relatively muted in the face of the structural constraints, thereby limiting the pace of
correction to the fiscal numbers.
In the current context of global economic stress, the focus has come back on India as regards
the extent of room that could be available under the fiscal to push up growth if the need
arises again. This is especially so after the large debt/GDP ratio in Eurozone areas as also in
the US has raised serious doubts about these countries’ ability to service their debt, leading
to even the downgrade of the sovereign debt rating of the US by S&P from AAA to AA+.
From India’s point of view, we think that even while the debt/GDP ratio of the sovereign
segment may be large, questions on the sustainability of the debt parameters might not
arise, mostly on account of the high nominal GDP growth of the economy. In this instance,
the high inflation trajectory in India appears to be of some advantage. Compared to global
counterparts, India has a lower sovereign public debt/GDP ratio and is unlikely to see any
risks of default or debt ballooning out of proportions. We also expect, that the government
would continue with its efforts to contain the fiscal deficit. While the implementation of the
GST and the DTC has gotten delayed, we expect that these would be in force within the
time period that we consider in this note.
Captive bond market for India’s sovereign debt. Sovereign debt for India is sold
internally and the government has a captive market to sell its securities as there are
stringent regulation for the banks and insurance companies to invest stipulated amounts
in government securities—both of the central and state government. For the banks, SLR
maintenance of 24% of its net deposit and time liabilities (NDTL) is mandatory. However,
for the purpose of participating in the LAF operations of the RBI, banks tend to maintain
SLR amounts at levels almost 2-3% higher than the mandatory requirement. As of March
2011, commercial banks and bank PDs together were seen to be holding 56% of
outstanding government securities. The insurance companies as also the pension and
general annuity businesses also are mandated to maintain certain amounts. Insurance
companies are mandated to invest and keep invested its ‘Investment Assets’ in
government securities amounting to not less than 25%. Further, for the pension and
general annuity business the requirement for investments into government securities
amount to not less than 20% of the fund. Provident funds and insurance companies hold
another 29% of outstanding government securities. FIIs are also allowed to hold
government securities. However, the cap on their holdings is US$10 bn of which US$5 bn
has to be invested in government securities of maturity of greater than 5 years. There has
not been much interest from the FIIs in the greater than 5 years bucket, implying that the
holding of the FIIs in the outstanding sovereign debt is minimal. Exhibit 4 details the
holdings of outstanding G-Secs (both Central and State governments).
Sovereign debt is internally held. Even though the total debt/GDP ratio of India is
around 72% (as of FY2010), the significant chunk of this debt is internally held. External
debt is not only low at 9.75% of total public debt as of June 2011, most of it is in the
form of debt from the bilateral and multilateral agencies where the rates of interest are
on the relatively lower side. Debt from multilateral agencies is around 6.04% of total
public debt while that from bilateral agencies is around 2.8%. The fact that the India’s
public debt is rupee denominated and internally held removes the risk of any external
sector influence on domestic debt. In other words, the risk of default and also
restructuring of sovereign debt is ruled out as the sovereign debt is internally held. Exhibit
5 shows the spilt between internal and external debt as a proportion of GDP. The notable
thing is that external debt has been on a downward trend from around 5.5% in FY1991
to 2.2% of GDP in FY2010. The liabilities of the centre and the states have also shown a
declining trend for the past 5-6 years though compared to a longer term it has increased
by about 10%.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Economy
Sovereign Debt
Don’t worry about the debt situation in India. In view of the long-drawn sovereign
debt crisis issue globally, we take a look at how India is positioned in the whole scheme
of things. India is comfortably placed, thanks to the healthy nominal GDP growth and
the way debt is held in India. Though borrowings have been high for the past few
years, the stability of the debt/GDP ratio is not an issue. Also, most of the debt is held
internally which reduces the interest rate risk to the economy.
Downgrade of sovereign debt would not be justified
The central government debt is around 45% of GDP which is within the limits prescribed by the
13th Finance Commission. Consolidated debt is around 72% as of FY2010 which is slightly higher
when compared to its peers in the EM space. However, the situation does not look risky for India
as most of the debt is internally held and financial institutions like banks and insurance companies
have to (by regulation) keep part of their NDTL/investments in government securities. This creates a
captive for government. Along with this the majority of the debt is internal debt thus insulating
the country from any foreign exchange risk. External debt is not only low at 9.75% of total public
debt as of June 2011, most of it is in the form of debt from the bilateral and multilateral agencies
where the rates of interest are on the relatively lower side.
Large market borrowings unlikely to danger debt sustainability
We apply the rule-of-thumb to assess the stability of the public debt in India. Two main metrics
that we use are comparisons between (1) growth rates of debt and nominal GDP and (2) nominal
GDP growth and average interest rate for interest payments. On both the metrics, we find that
barring the period from FY2000-FY2003, nominal growth rate has remained above the growth in
debt and also the average interest rate on interest payments. Hence stability is not an issue with
public debt. Even though the gross debt/GDP ratio for India is not too high (compared to the other
countries which are in crisis), still we check for a stricter test in terms of primary balance to interest
payments. Theoretically, if a country has high debt/GDP ratio (even if stability is not an issue) then
for debt to be sustainable it needs to have a primary surplus on the fiscal to comfortably meet
interest payments. India has not been in surplus for more than a decade now, yet the primary
deficit/interest payment ratio has improved till around FY2007. It deteriorated again owing to
expenditures on the farm loan waiver scheme, the sixth pay commission and fiscal measures to
support the economy during recent crisis. The trend has reversed since FY2011. We continue to
stress that a consolidation on the fiscal side would be needed in order to remove risks to debt
sustainability.
The debt/GDP trajectory does not worsen significantly in our stress-test scenarios
We look at 3 scenarios (1) interest rates for interest payments at 9%, (2) real GDP growth at 6.5%
and (3) a combination of both. Against our base-case scenario which projects debt/GDP at 62% in
FY2020E, we see debt/GDP increasing to around 72-74% with a combined effect of higher
interest rates and slower growth. However, we do not see much risk to stability of debt/GDP in the
medium-long run. Likely boost from reforms in taxation and rationalization of expenditure,
especially on subsidy front, will further lower the debt/GDP ratio.
Little rationale for any talk of debt rating downgrade for India
For India, concerns have been significantly raised time and again on the fiscal sustainability.
While the fiscal deficit had corrected by FY2008, it again increased sharply in FY2009 on
account of the farm loan waiver and the 6th Pay Commission awards. To complicate the issue,
the global meltdown post Lehman led to the Indian government also putting in further
accommodation in place by excise tax and service tax cuts. While some of this has been
reversed, we are still not back to the pre-crisis days, indicating that fiscal accommodation in
India continues. Unfortunately, for India, fiscal consolidation has been attempted through
reduction in the capital expenditures of the government while social sector expenditures
have continued to balloon over the years.
Exhibit 1 clearly indicates that there has been a sharp rise in the borrowings of the central
government over the years that have led to some sort of stickiness with regards to the
interest rate at which the government borrows. Further, Exhibit 2 indicates that the amount
of interest payments has increased sharply and the total wasteful expenditures in the form
of interest payments and subsidies account for more than 50% of revenue receipts. In the
final assessment, the constraint to correction in the fiscal deficit in India is mainly due to
structural impediments. Even when growth rates rise, the cyclical components remain
relatively muted in the face of the structural constraints, thereby limiting the pace of
correction to the fiscal numbers.
In the current context of global economic stress, the focus has come back on India as regards
the extent of room that could be available under the fiscal to push up growth if the need
arises again. This is especially so after the large debt/GDP ratio in Eurozone areas as also in
the US has raised serious doubts about these countries’ ability to service their debt, leading
to even the downgrade of the sovereign debt rating of the US by S&P from AAA to AA+.
From India’s point of view, we think that even while the debt/GDP ratio of the sovereign
segment may be large, questions on the sustainability of the debt parameters might not
arise, mostly on account of the high nominal GDP growth of the economy. In this instance,
the high inflation trajectory in India appears to be of some advantage. Compared to global
counterparts, India has a lower sovereign public debt/GDP ratio and is unlikely to see any
risks of default or debt ballooning out of proportions. We also expect, that the government
would continue with its efforts to contain the fiscal deficit. While the implementation of the
GST and the DTC has gotten delayed, we expect that these would be in force within the
time period that we consider in this note.
Captive bond market for India’s sovereign debt. Sovereign debt for India is sold
internally and the government has a captive market to sell its securities as there are
stringent regulation for the banks and insurance companies to invest stipulated amounts
in government securities—both of the central and state government. For the banks, SLR
maintenance of 24% of its net deposit and time liabilities (NDTL) is mandatory. However,
for the purpose of participating in the LAF operations of the RBI, banks tend to maintain
SLR amounts at levels almost 2-3% higher than the mandatory requirement. As of March
2011, commercial banks and bank PDs together were seen to be holding 56% of
outstanding government securities. The insurance companies as also the pension and
general annuity businesses also are mandated to maintain certain amounts. Insurance
companies are mandated to invest and keep invested its ‘Investment Assets’ in
government securities amounting to not less than 25%. Further, for the pension and
general annuity business the requirement for investments into government securities
amount to not less than 20% of the fund. Provident funds and insurance companies hold
another 29% of outstanding government securities. FIIs are also allowed to hold
government securities. However, the cap on their holdings is US$10 bn of which US$5 bn
has to be invested in government securities of maturity of greater than 5 years. There has
not been much interest from the FIIs in the greater than 5 years bucket, implying that the
holding of the FIIs in the outstanding sovereign debt is minimal. Exhibit 4 details the
holdings of outstanding G-Secs (both Central and State governments).
Sovereign debt is internally held. Even though the total debt/GDP ratio of India is
around 72% (as of FY2010), the significant chunk of this debt is internally held. External
debt is not only low at 9.75% of total public debt as of June 2011, most of it is in the
form of debt from the bilateral and multilateral agencies where the rates of interest are
on the relatively lower side. Debt from multilateral agencies is around 6.04% of total
public debt while that from bilateral agencies is around 2.8%. The fact that the India’s
public debt is rupee denominated and internally held removes the risk of any external
sector influence on domestic debt. In other words, the risk of default and also
restructuring of sovereign debt is ruled out as the sovereign debt is internally held. Exhibit
5 shows the spilt between internal and external debt as a proportion of GDP. The notable
thing is that external debt has been on a downward trend from around 5.5% in FY1991
to 2.2% of GDP in FY2010. The liabilities of the centre and the states have also shown a
declining trend for the past 5-6 years though compared to a longer term it has increased
by about 10%.
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