Growth via debt markets

Growth via debt markets

As the economic stimulus package has brought out in full force, the traditional response to recessionary situations across the world has been starkly Keynesian— “dig trenches and fill them up". However, in times such as these, when slowing of the growth rate has been accompanied by inflation rates well above the central bank’s tolerance level, a unique set of dilemmas confront policymakers. Pump-priming in such situations may actually accentuate inflation and, if not directly applied to government grass-root programmes, may suffer from the general lack of demand manifest during recessions.

In such times, re-channelling existing resources in the economy through tapping the debt markets may prove to be quite sound.

The tapping of domestic markets has its own advantages. First, the effects would not be as inflationary as pump-priming. Second, at times when private entrepreneurs may be wary of substantial financial commitment for a large portion of the infrastructure projects, debt markets may be a viable alternative especially for the better rated states. Moreover, the added facet of financial discipline brought about by the process inclusive of the credit rating procedures would be especially useful at times when risk perceptions are of great importance.

There is little doubt that there remains a tremendous investment gap in the infrastructure segment. Especially given the federal structure of the Indian Union, a substantial amount of this expenditure on asset formation would also have to be borne by the state governments. However, even during the better growth periods the proportion of the total capital outlay to the gross state domestic product of even better performing states has been quite dismal.

To give an example, the ratios for the two most industrialized states, Maharashtra and Gujarat, have been 2.1% and 2.3%, respectively. Surprisingly, given the tremendous need for resources to finance this substantial unmet need, actual levels of market debt being taken by major state government’s year-on- year have shown a decline in the past few years. A sample of eight major borrowing states shows that the annual figure for internal debt taken has actually fallen from Rs89,537 crore in 2003-04 to Rs72,337 crore in 2006-07. This is despite the fact that there appears to be scope for some of the better rated states to access the debt market without seriously impinging on their debt sustainability. For example, in three of the major south Indian states, Tamil Nadu, Karnataka and Andhra Pradesh, the overall debt to revenue receipt ratio remains below the Reserve Bank of India benchmark of 200% at 154.3%, 161.7% and 172.7%, respectively.

A primary reason could be the prevailing fiscal responsibility framework (the Fiscal Responsibility and Budget Management Act, or FRBM) that stipulates targets for certain rewards. However, strictly following fiscal targets during difficult times like these can be questioned. The mid-year review of the Indian economy was tabled in Parliament on Tuesday. It is suggested that the government should follow a more aggressive monetary policy to ensure a smooth credit flow particularly to the stressed sectors while maintaining a high quality of lending standards.

The second dose of fiscal stimulus package for the exporters is expected to be announced before the end of this week. Due to these fiscal stimuli, the fiscal deficit may jump to 5% of gross domestic product this year, which is fairly above the target of 3% as outlined in the FRBM Act.

As a result, at such times when the savings rates remain well above 30% and policymakers veer around to the Keynesian paradigm of fiscal injections, channelling a part of this historically higher savings rate to higher asset formation via the debt markets would serve as a remedy for strengthening the base for current and future economic growth.

The author is chief economist, CARE Ratings. Comments are welcome at