A Balance Sheet crisis in India??

A random google search bought me to this paper which was an immediate read . The paper’s title is same as the post and needless to say the paper is quite stimulating. It was written in 2004  and needs to be updated with 2009 figures. Though, on reading it one does not see much changing even when we update the figure(hope i am wrong).

The paper is written by Nouriel Roubini and Richard Hemming. Roubini along with other economists pioneered balance sheet approach (see this paper as well)  to understanding crisis in emerging economies (though the most imp purpose is to predict the crisis in advance but predicting a crisis is quite difficult).

The paper looks at balance sheet issues in India. I will just point to the conclusion as it has all the juice:

In summary, India resembles in some important dimensions the vulnerabilities of countries that experienced sovereign defaults or near-defaults (Russia, Ecuador, Argentina, Pakistan, Ukraine, Uruguay). While in some dimensions, India is less vulnerable (modest rollover/liquidity risk, lack of currency mismatches and limited liability dollarization, smaller current account imbalances, lower external debt, financial repression and capital controls) in other dimensions it is as vulnerable if not more vulnerable.

Indicators such as the fiscal deficit and primary deficit as a share of GDP, public debt as a share of GDP and of revenue, primary gaps, a heavily managed exchange rate, reliance on banks for financing of the deficit, weak banking and financial systems, and hot money inflows leading to increases in foreign liabilities all look as bad and often worse in India compared to other countries that experienced severe sovereign debt servicing problems. Many indicators also look worse in India compared to other emerging market economies with a similar or lower credit rating.

 Excessive reliance on some indicators of vulnerability (liquidity risk and currency mismatches) that appear to have improved relative to the 1991 crisis and relative to other emerging market economies that experienced crises may be deceptive. India may be as vulnerable to a financing crisis as some other economies that have experienced severe financial turmoil. While a financing crisis may not be imminent, viewing the risk of a crisis as minimal over the medium term may turn out to underestimate the vulnerabilities of the current debt path. Indeed, the fact that the primary deficit has increased and become higher in spite of the acceleration of GDP growth in 2003 suggests that the cyclically adjusted primary deficit and primary gap are even wider than the raw figures.

The main concern as per the paper is the fiscal deficit and public debt ratios. Justa  quick glance tells you things have hardly improved. Let us look at most vulnerable factors first:

  • Deficits are still high (the paper says the group of emerging markets to which India belongs averages fiscal deficit is 4.5% of GDP). It has declined but when you include off-balance sheet items we are back to square one. Moreover for 2008-09 and 2009-10 fiscal deficit is expected to be 6.0% and 5.5%. And this does not include off balance sheet items and state deficits.
  • Debt Ratios also  have the same story. The ratio to GDP has improved in recent years but the absolute levels continue to rise. With GDP growth slowing, the ration is expected to rise again
  • I also calculated the debt/tax revenue ratio. The emerging market average is 289% but we are around 500% range till about 2004-05 and declined to 414% in 2007-08. It is projected to be 382.81 in 2008-09 but with final estimates is expected to rise as tax revenues decline and expenditure levels rise.

Now let us look at less less vulnerable areas:

  • modest rollover/liquidity risk – became very high in October -December 2008. But is now managed pretty well. Though concenrs are there on liquidity because of the huge govt borrrowing program. The press also keeps reporting that liquidity risks for small firms remain
  • lack of currency mismatches – there were problems with real estate /oil sector who had taken huge foreign currency exposures. I don’t know the status now
  • limited liability dollarization- this is controlled because of RBI’s stiff control
  • smaller current account imbalances – has begun to rise again. So far managed by huge capital flows which have dried in this crisis. Hence BoP in huge deficit after a long time
  • lower external debt – this is still managed quite well with limited external debt
  • financial repression – By financial repression it means banks are forced to hold to government debt in their portfolios and quality of government debt is questionable. Banks should be free to allocate their portfolios. Well, this is true but the original problem is high fiscal deficit and unless we fix it, we cannot really do away with SLR. (SLR has been lowered from 25% to 24% but it was to take care of liquidity troubles).  

As I said, nothing much seems to have changed. The original problem of high fiscal deficit/debt continue. Dr Reddy in an excellent overview on indian fiscal policy said:

Despite considerable improvement in the fiscal scenario, both at the centre and in the states, India’s combined fiscal deficit (centre and state), as a percentage of GDP, still continues to be one of the highest in the world.

Dr Acharya also said the same in his paper on Indian economy and numeorus others have made the same point. All reforms are criticially dependent on how well we manage the budget consolidation process. It is time we take the Swedish lessons (or others) a bit too seriously. 

4 Responses to “A Balance Sheet crisis in India??”

  1. Tirath Says:


    There is a footnote that says external liabilities are at historical rates. In which case it would be a serious error in calc. I hope I am wrong.

    Thanks for this – nice post.
    Please shed some light on how public debt ratios would affect the health of the economy

    • Amol Agrawal Says:

      Thanks for pointing this out. Yes, it is an error. But we dont really know the necessary details to make adjustments. I haven’t seen any academic paper providing any insights as well. Till then, we just need to have a quick glance to get some idea. That was actually the purpose of pointing the post. I would love to a detailed analysis on this but just dont get enough time.

      If Public debt Ratio keeps rising, it would imply either govt debt levels are rising. To pay off debts govt would raise taxes in future. Now, suppose we have a situation like today’s when govt is doing all these programs (public debt rising) to encourage people to spend,consume etc. As people see taxes rising in future, they start saving now leading to undoing of the govt plans. We have higher debt and lower consumption as well.

  2. Minh Guiliani Says:

    I was simply browsing for related blog posts intended for my project research when My partner and i happened to stumble on yours. Thanks for the valuable information!

  3. What lessons did IMF learn from South East Asian crisis? « Mostly Economics Says:

    […] mostly in dollars. IMF has now developed a very important tool – balance sheet approach (see India case study as well), which helps it assess the currency and maturity mismatches of the entire economy. This helped in […]

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