Opinion: Barry Eichengreen & Poonam Gupta
The literature points to the importance of prior financial conditions (capital inflows and real appreciation in the pre-taper period) financial market structure (the size of financial markets) and select macroeconomic variables in explaining the differential impact of the taper announcement. Specifically countries more dependent on external finance prior to Ben Bernanke’s 2013 announcement of the intention to taper were impacted more strongly.
On November 3 the US Federal Open Market Committee (FOMC) announced that it would reduce the scale of its asset purchases by $15 billion a month starting immediately. Do emerging markets such as India need to prepare for a replay of the taper tantrum of 2013?
The literature points to the importance of prior financial conditions (capital in ows and real appreciation in the pre-taper period) financial market structure (the size of financial markets) and select macroeconomic variables in explaining the differential impact of the taper announcement. Specifically countries more dependent on external finance prior to Ben Bernanke’s 2013 announcement of the intention to taper were impacted more strongly.
Also important was the size of countries’ financial markets measured by the stock of portfolio or total external private financing. This is consistent with the idea that investors seeking to adjust their portfolios tend to exit from positions in countries with relatively large financial markets since they can rebalance without significantly moving prices against themselves.
In a November 2021 NCAER working paper ‘ The Taper This Time’ focusing on 14 larger emerging markets (EMs) along with Rishabh Choudhary we examine how these determinants have evolved in the eight years since the 2013 taper tantrum.
At one level these economies are in a better position today. In ation has declined. Policy rates are lower providing more scope for stabilising adjustment. Current account balances as a share of GDP are stronger than in 2010-12. Real exchange-rate appreciation has been limited or been avoided more successfully this time while reserve adequacy has improved almost everywhere. Credit growth is more subdued and cumulative portfolio in ows were uniformly smaller in 2019-21 than in 2010-12.
The debt situation however paints a mixed picture. With EM governments running larger budget deficits in response to Covid general government debt as a share of GDP is higher. Reassuringly an increasing fraction of this debt is denominated in domestic currencies. But a significant fraction in many national cases is still sold to foreign investors who may seek to rebalance away from EMs as interest rates begin to rise in the US and other advanced economies.
India is on the favourable end of the spectrum in terms of most indicators of EM financial vulnerability. The current account deficit (CAD) is small. Real exchange- rate appreciation has been limited. Cumulative portfolio in ows have been smaller relative to GDP than in 2010-12. External debt stocks are low by EM standards. External financing needs are limited and smaller relative to GDP than in 2010-12. Reserve cover is improved.
Where the country stands out is in its fiscal stance. The general government debt and deficit as shares of GDP are high by global standards. India’s debt-to-GDP ratio in the last decade (averaging 68%) and fiscal deficit-to-GDP ratio (averaging at about 7%) are high among comparators. Tax revenues as a share of GDP have been stagnant or have risen only slowly. Tax effort so measured has been below the average of other countries at similar income levels. Direct tax collection has been particularly low. Recurrent expenditure accounts for most general government expenditure while capital spending on infrastructure is only about 3.5% of GDP.
Covid-19 has further widened the budget deficit and elevated the debt. These totalled 12.3% and 89.6% of GDP respectively in 2020-21 and are projected by the International Monetary Fund (IMF) to moderate slightly to 10% and 86.6% as GDP recovers this fiscal year. The general government primary deficit net of interest payments was 7.4% of GDP in 2020 and is estimated by IMF to be 5.7% in 2021.
The good news is that debt and deficit ratios do not figure prominently in analyses of the 2013 taper tantrum. It is further reassuring that general government debt is held mainly at home and denominated in rupees. RBI estimates that external government debt as of 2021 is just 4% of GDP. More than three-quarters of this is external debt on government account under external assistance – concessional assistance from official creditors who are unlikely to cut and run.
Debt Closing In
The bad news is that a debt-to-GDP ratio of 87% is high by EM standards. It would be risky to let it go higher. Since the turn of the century the real growth rate-real interest rate differential has averaged around 5 percentage points. This means that India can run a primary deficit of 4.5% of GDP without seeing its debt-GDP ratio move higher. Of course there is no guarantee that the growth rate-interest rate differential will remain so favourable. The post-Covid growth environment could be less supportive than in the halcyon days of 2014-16.
Similarly global interest rates could go up. Yields on GoI’s 10-year securities seem to move with US 10-year treasury yields. The elasticity with respect to US rates approaches unity. If US yields are now going up even stronger steps seem to be needed to stabilise the debt-GDP ratio.
With GDP projected to bounce back post-Covid there is no immediate crisis of debt sustainability. If growth does indeed run at 8% in 2022 as conditions normalise the debt ratio will fall in the short run. But there are reasons to worry about the medium term. The IMF in its Fiscal Monitor and latest Article IV consultation with India imagines that the primary deficit as a share of GDP will fall back to its lower 2012-19 average of 2.4% by 2026.
The question is how. Tax-to-GDP ratios generally do not increase rapidly or sharply in the short run. Thus IMF projects general government revenue as a share of GDP as rising very slightly from 19.2% this year to 19.8% in 2022-26. It follows that making a dent in the deficit will require spending restraint. The IMF imagines that general government expenditure as a share of GDP will fall from 30.4% this year to 27.9% by 2026 basically to pre-crisis levels.
This is optimistic. The need for health expenditure will rise. More spending will be required to make up for the loss incurred in school closures. There is the ongoing need for public investment in infrastructure. When required to reduce public spending as a share of GDP governments tend to reduce capital expenditure which is counterproductive for economic growth. The IMF projects a fall in GoI’s capital expenditure as a share of GDP between now and 2026. Following this avenue would be a mistake.
This leaves the question of what to cut. Saying ‘Cut food fertiliser and fuel subsidies’ is easy. Doing it is hard. What happens when public debt relative to the resources that GoI is able to mobilise rises even higher? When raising taxes or cutting public spending has been infeasible governments have responded in two ways. When the debt is held externally they restructure. When it is held internally they in ate. You can draw your own conclusions.
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