Why India is not in a crisis despite high debt levels?

I was just reading this excellent paper by Ricardo Hausmann and Catriona Purfield on politicaleconomy of India’s fiscal deficit (HT: This IMF paper whose reference list led me to this paper). The paper was written in 2004 and looks at India’s FRBM architecture.

Its main suggestion is that as India is a federal country, Indian states need to join the FRBM as well in order to make it more meaningful. As the same IMF paperpoints only 2 states (West Bengal and Sikkim) have not adopted some version of FRBMand rest have joined in. His other suggestion is to have a central scorecard-keeper (just like CBO) tracking govt’s deficits and reporting the developments.

However what I like most about this paper is an answer to a puzzle which has been bugging me for a while now- Why are we so less concerned about fiscal deficits in India? Why and how India has avoided a crisis till now?  It was vouched as the biggest reform in India in 2000s but has hardly moved forward. Shankar Acharya, a noted Indian economist in his review of Indian economy post 2000s says:

It is ironic that after the enormous success in fiscal consolidation achieved in 2002-2008, the primary macroeconomic challenge confronting India for the medium-term is again one of restoring fiscal balance. In some ways the task ahead is harder because it may be unreasonable to expect the kind of revenue buoyancy experienced in recent years. Also, given the growing expenditure demands of recently launched populist schemes (such as the National Rural Employment Guarantee and the farm loan waiver) the prospects for expenditure compression may be limited.

The same issue has been raised by numerous others (PM’s EAC, Dr Reddy and now Dr Subbarao) but there is no real panic. As Hausmann et al point:

 

 India is in an enviable position. Growth is high, the external position is strong, and inflation and nominal interest rates are low. Yet there is a nagging concern about India’s large fiscal imbalances. With the general government deficit exceeding 10 percent of GDP and the public debt representing almost 4½ years of revenue, there are reasons to worry.

 A central Fiscal Responsibility and Budget Management Law (FRBM) has been approved, and some states are following suit. But in India, the job of convincing the politicians and society that adjustment is necessary is made more difficult by the apparent absence of any symptoms of fiscal illness. On the one hand, the debt burden is comparable only to those witnessed in crisis countries such as Turkey and Argentina. But markets are giving no indication that they find it excessive: nominal interest rates are low and declining; international capital inflows are large; and banks have ample liquidity. Usually, it is politically easier to resolve a crisis, once it happens, than to prevent one. Will India be able to garner enough political agreement so that it can usethe current good times to correct its fiscal imbalances?Though the paper was written in 2004 we don’t see anything changed. The only thing that would change is the comparison of debt/deficit comparisons with other economies (it is in August company as US, UK etc levels are higher, so we can now say it is much lower than developed econs…). Despite record deficits, the government is pretty confident of carrying forward its growth agenda without any signs of crisis.

 

 

 

It looks at the reasons:

 

 

 

 

 

Elsewhere, the magnitude of fiscal imbalances in India would presage a fiscal crisis (Table 1). Yet, this is not happening. India’s credit rating is better than many major emerging markets including pre-crisis Argentina and Turkey (Figure 1). But indebtedness ratios are poor predictors of credit ratings: the indebtedness ratios of many emerging markets are comparable to those of highly rated industrial countries.

To get a more accurate picture, the authors build a simple model of optimal debt levels in a country. I would skip the model details and just report India findings (please see the paper as that is how a model should be explained):

 At just under 18 percent of GDP, India’s revenue base is below the developing economy average of 26 percent of GDP, but it is far more stable. The volatility in India’s revenue  base is one-third of that of other developing countries, owing to the low volatility of GDP growth (Table 2). A stable revenue base implies that India has a lower variance of  and have a lower risk premium. But the lower volatility of growth and fiscal revenues in India is not just the consequence of aggregation across such a large economy. Braun, Hausmann, and Pritchett (2002) find the average volatility of GDP growth in the states of India is similar to that of the United States and to the cross-country volatility in Western Europe, and is about a third of that Eastern Europe, sub-Saharan Africa, and Latin  America.

Hmmm…Further they develop a matrix which plots domestic and international original sin (Most emerging market countries borrowing abroad cannot denominate their obligations in their own currency, a fact labeled original sin by Eichengreen and Hausmann (1999)). For India:

 

Figure 5 shows measures of the two forms of original sin: the ability to borrow abroad in domestic currency (OSIN) and the ability to borrow at home at fixed rates, long maturities and in local currency (DSIN). 

 

 

  

India is in the second quadrant with no ability to borrow abroad in rupees but one of the lowest measures of domestic original sin in emerging markets owing to its deep long-term fixed-rate rupee market in government securities. Countries in this quadrant have a statistically significant higher probability of having exchange controls than countries in other quadrants. This suggests that countries with international original sin can only develop long-term domestic markets if they are sheltered from capital movements.

 While India suffers from international original sin, it has a very small foreign currency public debt. This implies that exchange rate movements  per se  do not have a significant fiscal impact. Moreover, the long duration of its domestic debt implies that shocks to the interest rate take a long time in affecting the fiscal deficit. Both characteristics may explain both India’s low macroeconomic volatility and its high debt tolerance. 

Excellent stuff.  The puzzle has been solved quite a bit. However, does that imply India need not worry?

 

But complacency here may be misguided. First, while the public debt is long-term, a significant portion is held by banks that fund their positions with short-term deposits.  Hence, in a scenario of a significant jump in long-term interest rates banks could loose a significant amount of capital. While interest-rate risk is a valid concern, banks in India have conservatively valued their assets using mark-to-market techniques which provides them some cushion to help absorb trading losses from rising interest rates.

 

 

 

 

 

 

The second reason why complacency may be misplaced is that India’s tolerance for debt makes the political system and society as a whole less responsive to debt accumulation. Consider two countries. One has a very volatile  

Wow!! It says it all. I have always felt something like that is bound to happen. We are just too casual about the precarious state of public finances.  

PS.

The paper was presented at this NIPFP- IMF comference (which means more papers to read). Ashok Lahiri comments on this paper. He agrees it is a problem but douses much if the fire raised by Hausmann.  

x and the other has a very stable x. Assume both countries have unsustainable fiscal policies that will inevitably end in a crisis. The country with the lower variance of x will have the crisis at a higher level of debt. This may complicate the crisis when it happens and may lead to a permanently higher tax burden or lower primary spending in the post-crisis period. Just as with cancer, it may not be good in the long run to be symptom-free: it prevents the patient from taking early action.

16 Responses to “Why India is not in a crisis despite high debt levels?”

  1. Why India is not in a crisis despite high debt levels? « Mostly … Says:

    […] Why India is not in a crisis despite high debt levels? « Mostly … […]

  2. Interest Rates » Why India is not in a crisis despite high debt levels? « Mostly … Says:

    […] Read the rest of this great post here […]

  3. Why India is not in a crisis despite high debt levels? « Mostly … | Considerable Debt Settlement Blog Says:

    […] unknown wrote an interesting post today onHere’s a quick excerpt6 ethnicity, gender, disabilities, class, commerce, settlement, conservation, warfare, rather than from bad water, so Emma was confused. Money 101- Reverse Mortgage Warning Money 101- California Muni Bonds. management in southern California during the 20th century. The settlement was offered with no admission of liability from the defendant. Debt Negotiation, Debt Settlement & Credit Repair! COM located at the Redstone Building, 2940 16th Street, Suite #209 SF CA 94110. San Francisco and Monterey and begin the settlement of California. I’m more comfortable with approximately a 33% debt. Pre Settlement personal injury lawsuit funding can help a plaintiff in more of money to help pay for bills but some don't want to risk faller deeper in debt. By the way, what about the border along NM, AZ and CA? iron, heavy; wine, bad water; a gun, a bow; governor, a staff- bearer. settlement has changed and that a long-term surplus sale, which […] […]

  4. Why India is not in a crisis despite high debt levels? « Mostly … | Debt Settlement Asset Blog Says:

    […] unknown wrote an interesting post today onHere’s a quick excerptAlabama law takes it a footprint further and not alone limits molestation from appeal agencies, but too from the pilot creditor as well. icary shoiuld ratesdo magnolia globaapitol: diiep debtpeach debthartland . Creditors acknowledge this and may use it to their reward in the collections process. We all consume heard it before; debt colonization is a discriminate solution for those who birth debt problems. This organization has locations throughout the county. Debt negotiation and settlement letters including phone script to use when. Baldwin including the Eastern Shore, Magnolia Springs, Perdido Beach, Josephine. A creditor prefers to put a lien on your domicile since it commonly increases in assess across time, which agency the payoff from your home’s cut-rate sale volition be higher, and hence they’re Thomas More likely to really get gainful back. Possibly a permanent settlement stood where the town of Stanley is now located. Enetez is your number 1 […] […]

  5. Twitted by FinishWealthy Says:

    […] This post was Twitted by FinishWealthy […]

  6. Why India is not in a crisis despite high debt levels? « Mostly … | Debt Settlement Aids Blog Says:

    […] unknown wrote an interesting post today onHere’s a quick excerptOn the one hand, the debt burden is comparable only to those witnessed in crisis countries such as Turkey and Argentina. But markets are giving no indication that they find it excessive: nominal interest rates are low and declining; … […]

  7. Seo Services India | InternalSEO Says:

    […] Why India is not in a crisis despite high debt levels? « Mostly … […]

  8. I need to come up with a name for a website, any ideas? Perhaps a logo as well, HELP? | Goodwill Auction Says:

    […] Why India is not in a crisis despite high debt levels? « Mostly … […]

  9. How to calculate nominal interest rate? | Loan Calculator Says:

    […] Why India is not in a crisis despite high debt levels? « Mostly … […]

  10. Emerging markets should be aware of their debt intolerance « Mostly Economics Says:

    […] are based on this paper written by Carmen along with Rogoff and Savastano. This is a problem with India as […]

  11. GM Says:

    High debt tolerance doesn’t put India outside the span of the debt spiral. The 18% of GDP as revenue collection is a dodgy figure – what I have down is closer to 12%. At public debt of 80%, average financing cost between 6 and 7, we’re talking 6% or half the GDP by my calculations in debt servicing. That is insane, because the rate of growth of GDP even at 7% (revenue expansion of .84%), will struggle to keep pace with the rate of increase of financing debt – so if you throw in consistent deficits, this isn’t an economy than can absorb a Japan-esque 172% of GDP sort of debt level. One severe slowdown and it’s game over. Inflation is how they hope to limit it, but they need the rest of the world to give us growth for inflation to be the preferred tool. Managed economies fail, eventually. It just takes a while.

  12. GM Says:

    correction above – that should read 4.8 to 5.6 percent, not 6 percent.

  13. Don Draper Says:

    Eventually even the best laid plans by the India’s government will not stop them succumbing to the devastation of debt and the printing press…

    The most vulnerable country to default right now is Venezuela with Mr. Chaves in charge

  14. DebtEliminationDon Says:

    Debt relief will one day be a big issue in India as it is here if they follow the same economic strategy as we have done. That is why I tell my readers at http://www.creditcarddebteliminationnow.com/ to get out of debt now to insulate them from any potential fallout of a failed fiat money strategy.

  15. debt settlement services Says:

    debt settlement servicing company…

    Why India is not in a crisis despite high debt levels? « Mostly Economics…

  16. seo, seo optimizācija, seo pakalpojumi, mājas lapas optimizācija, interneta mārketings, interneta reklāma, reklāma internetā Says:

    seo, seo optimizācija, seo pakalpojumi, mājas lapas optimizācija, interneta mārketings, interneta reklāma, reklāma internetā…

    […]Why India is not in a crisis despite high debt levels? « Mostly Economics[…]…

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.


%d bloggers like this: