Historically, India has had an impressive record of paying its external debt. According to Carg, this has been the case since 1947, when the country got its independence from Britain.[1] The country has always met its external debt obligations despite the fact that the country’s external borrowing increased at higher from the 1980s. However, international lenders have in the recent past been put on great alert because of the unfavorable economic developments in the country that have had a negative impact on the country’s creditworthiness. As a country, India does not reap the expected returns from remittances because of its high rate of external debt. Although the country is not in an external debt crisis, increased borrowing in foreign denominations will definitely lead to a debt burden and crisis. This paper will argue that continued imbalances in India’s external debt position are likely to have a negative impact on the country’s external sector, the strength of the local currency, and capital inflows.
A country’s external debt must be within sustainable limits for it to be properly managed and to create an environment that promotes the growth of the local economy. According to Roy, there is a strong nexus between a country’s external sector, external debt, and overall economic growth.[2] These linkages explain why external debt can have both short-term and long-term effects on a country’s economy. The external debt inventory of a country is a double-edged sword that can result in an economic crisis or catastrophe that may not be anticipated. As a developing nation, India has been accumulating external debt in the recent past to meet its developmental objectives. However, there is the danger of having a deficiency in domestic savings if the country continues with controlled external borrowing. In other words, unsustainable debt commitments can strangle the country’s economy if urgent measures are not taken to bring the necessary balance in a country’s external debt inventory.
India has, in the last two decades, been experiencing a depreciation in the value of its local currency because of its growing external debt. According to Augustine and Kumar, “Indian Rupee has depreciated around 50 percent against the US Dollar for the last two decades.”[3] This will continue to have devastating effects on the already struggling economy because it will be more expensive to borrow from abroad and, in the process, increase the debt burden. Augustine and Kumar observe that “At present, more than 63 percent of India’s external debt is foreign currency-denominated.”[4] This means that meeting the debt commitment in foreign currency will mean that the country will repay more than the rate at which they borrowed because of the depreciating currency. As a result, the lenders are paying more attention to the balance sheet channel because of the depreciating rupee.
Repaying the external debts in foreign currency means that local Indian economy will continue to lose much-needed foreign currency reserves required to stabilize the economy. As a result, India’s external debt dynamics have been affected by increased borrowing in foreign currency that has led to a significant increase in external indebtedness. Augustine and Kumar observe that “one rupee depreciation increases external debt to GDP ratio by 0.75 percent while in the long run, the increase is 1.26 percent.”[5] The ratio is not at a crisis level, but something must be done before the situation goes out of control. Therefore, debt valuation is more likely to change as the country continues to rely on external debt to finance its development programs.
India’s reliance on external debt will continue to hinder the country’s capital inflows. According to Sethi and Patil-Dake, capital inflows such as private equity flows and focusing on increasing trade in terms of exports is the best way to ensure that India get the necessary foreign exchange to stabilize its economy. [6] The international financial sector has been reluctant to invest in India in recent past because there is no promise of higher returns and the limited liquidity due to unsustainable debt obligations. Relying on external financing in terms of aid and debt flows will not guarantee long-term economic stability. The country’s economic liberalization policies that were initiated in the 1990s to increase Foreign Direct Investments are no longer sustainable because of the external increasing debt burden.[7] Thus, the economic liberalization policies that were meant to encourage foreign direct investments have been affected the unsustainable tax burden and the depreciating currency that discouraged foreign investments in the country.
As a developing economy, India is bound to experience a shortfall in its revenue collections, and this ends up affecting its external debt obligations. Also, a deficit in domestic financing means that external debt borrowing become an option for the struggling economies. Chauhan argue that some of the external loans are not denominated in rupee and come at high interest rates leading to an external debt burden.[8] Although borrowing from abroad helps in covering budget deficit and financing local development, the long-term impacts on a developing economy may not be positive. The other challenge is the utilization of the external debt. The mismanagement of external debt without investing in economic project that can spur domestic growth is what leads to long-term economic challenges. This means that a country like India might invest projects that have no viable economic returns. Also, the situation can become worse when there is massive corruption in the projects that are funded by external debt. There are situations where developing countries are forced to take one external debt to repay another external debt.[9] As a result, such issues increase the probability of debt default and the country’s credit-worthiness.
Although successive Indian governments have over the years tried to manage the external debt situation, there is a likelihood of an external debt crisis if domestic factors like the depreciating rupee and limited liquidity continue to spiral out of control. The exchange rate volatility because of the external public debt that is borrowed in foreign currency has a negative impact on local business people that import goods using foreign currency. This leads to massive import losses. This means that external debt management should be the priority of policymakers in India. The volatile and appreciating foreign exchange in recent years has been detrimental to India’s economy. For instance, “the exchange rate for India increased from 22 Rs in terms of Dollar in 1991 to 70 Rs in 2019.”[10] In developing nations, the most significant micro-economic variable is the exchange rate. Also, capital flows are linked to the stability of the currency, and this automatically means that it has a direct link to how a country manages its external debt. This means that effective debt management will lead to an increase in the foreign currency serves when there is an environment that promotes capital inflows. Increasing the volume of transactions at the international market can only happen when there is a proper balance when it comes to the external debt. Transparency in explaining the status of external debt can also help in preventing unnecessary panic or speculation when it comes to capital inflows.
Although India has increased its borrowing in recent years, it is important to note that the country is not at a crisis level. However, the situation can get worse if the borrowing continues without proper safeguards. This means that uncontrolled borrowing and limited capital inflows may have adverse effects on the economy and lead to an external debt crisis. What has saved India from going into a crisis is the long-term maturities of its external debts. According to the Hindu, domestic borrowing in local currency and high rates of economic growth in India contributed to the limited risks when it comes to India’s debt situation.[11] In this case, “the policy advice is for the medium term to have an ambitious fiscal consolidation plan that brings down the deficits, especially the primary deficits through a range of measures.”[12] The stability of the debt level will depend on fiscal consolidation and prudent management of funds borrowed from external sources.
In conclusion, it is evident from this discussion that continued imbalances in India’s external debt position are likely to have a negative impact on the country’s external sector, strength of local currency, and capital inflows. Like other developing countries in South Asia, India has been experiencing some external debt imbalances that have led to the depreciation of the local currency and limited liquidity in the country economy. The limited liquidity is more likely to affect capital inflows because of economic uncertainty and reduced probability of good economic returns. Although India has managed to avoid a crisis through long-term maturities and considerable domestic borrowing, continued uncontrolled borrowing from the external market in foreign denomination will lead to continued depreciation of the rupee, and decline in capital inflows, and poor performance of the external sector. In this case, there is a strong nexus between a country’s external sector, external debt, and the overall economic growth.
Bibliography
Garg, Ramesh C. “India’s External Debt: Problems and Prospects.” The Indian Economic Journal 41, no. 1 (1993), 42-50. doi:10.1177/0019466219930104.
Augustine, Blessy, and Lakshmi Kumar. “Original Sin, Currency Depreciation and External Debt Burden: Evidence from India.” International Journal of Economics and Financial Issues 10, no. 3 (2020), 58-68. doi:10.32479/ijefi.9487.
Sethi, Nandita, and Jayashree Patil-Dake. “Coping With Global Meltdown: India’s External Sector.” International Journal of Economics and Finance Studies 3, no. 2 (2011.), 217-230.
Chauhan, Piyush et al. “Impact of External Debt on the Economy of India.” Test Engineering & Management, 2020, 6072-6079.
The Hindu. “India Has High Debt Like China, but Risks Are Moderated: IMF.” The Hindu. Last modified October 11, 2023. https://www.thehindu.com/business/Economy/india-has-high-debt-like-china-but-risks-are-moderated-imf/article67407321.ece.
[1] Ramesh C. Garg, “India’s External Debt: Problems and Prospects,” The Indian Economic Journal 41, no. 1 (1993): 42.
[2] Arup Roy, “Nexus between economic growth, external debt, oil price, and remittances in India: New insight from novel DARDL simulations,” Resources Policy 83 (2023): 103742.
[3] Blessy Augustine and Lakshmi Kumar, “Original Sin, Currency Depreciation and External Debt Burden: Evidence From India,” International Journal of Economics and Financial Issues 10, no. 3 (2020): 58.
[4] Augustine and Kumar, “Original Sin, Currency Depreciation and External Debt Burden” 58.
[5] Augustine and Kumar, “Original Sin, Currency Depreciation and External Debt Burden” 58.
[6] Nandita Sethi and Jayashree Patil-Dake, “Coping with Global Meltdown: India’s External Sector,” International Journal of Economics and Finance Studies 3, no. 2 (2011.), 222.
[7] Sethi and Patil-Dake, “Coping with Global Meltdown” 222.
[8] Piyush Chauhan, “Impact of External Debt on the Economy of India,” Test Engineering & Management, 2020, 6072.
[9] Chauhan, “Impact of External Debt on the Economy of India,” 6075.
[10] Chauhan, “Impact of External Debt on the Economy of India,” 6075
[11] The Hindu, “India Has High Debt Like China, but Risks Are Moderated: IMF,” The Hindu, last modified October 11, 2023, https://www.thehindu.com/business/Economy/india-has-high-debt-like-china-but-risks-are-moderated-imf/article67407321.ece.
[12] The Hindu, “India Has High Debt Like China, but Risks Are Moderated.”
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