INDIA AND INTERNAL DEBT TRAP

Summary

Delivered as the M.V. Sirur Memorial Lecture in Hubli in February 1999 and published by the Forum of Free Enterprise, this pamphlet by Dr. S.R.K. Rao — a former Principal Adviser to the Reserve Bank of India — diagnoses the late-1990s Indian economy and warns that the Centre is sliding into what he had earlier christened the “Internal Debt Trap”. After acknowledging genuine post-Independence achievements in foodgrains, fertilisers, heavy industry, banking spread and infotech, Rao argues that these gains are dwarfed by population pressure, persistent mass poverty, sluggish 1998-99 GDP growth, agricultural stagnation, industrial deceleration and a fragile external sector marked by widening trade and current-account deficits and only a trickle of FDI relative to China.

Much of the lecture is a forensic critique of public-sector banking and the financial regulator. Rao tracks Non-Performing Assets at commercial banks past Rs. 48,000 crore, capital adequacy below Basel norms at a third of nationalised banks, “evergreening” of bad loans at Development Financial Institutions, and a series of scandals — the 1992 securities scam, the Urea Scam, irregularities at IDBI and revoked licences at CRB Global, Cox & King and Bank of Gujarat. He scrutinises the Resurgent India Bonds operation, calculates that repayment burdens of US$8-10 billion could fall on the country, and observes that the dollars raised for infrastructure sit idle while State Bank of India on-lends them at 9.5 per cent to foreign banks that recycle them into 17.24-per-cent consumer-durable credit.

The constructive half of the lecture asks what the Reserve Bank should become. Echoing the Narasimham Committee, Rao backs separating supervisory functions, considers a cynical proposal to convert the RBI into a pure Monetary Authority, and recommends a high-powered Banking Commission, parliamentary accountability for the Governor, and Cabinet-rank status for the post. He closes by recalling the speech he gave in 1986 in which he first coined the phrase “Internal Debt Trap” — defining it as the point at which government borrowings can no longer cover even debt-servicing charges — and shows, via the RBI’s own 1997-98 Report on Currency and Finance, that the market has stopped absorbing Centre’s gross borrowings and the Bank itself is now soaking up nearly 40 per cent through devolvement and private placement. The rendered pages stop mid-discussion of Union Budget expenditure composition.

Key points

• Frames India at the end of the 1990s as standing at a “QUO VADIS” crossroads — real post-Independence gains in foodgrains, banking spread and infotech offset by population growth, near-40 per cent poverty incidence and sluggish 1998-99 GDP estimates of 4.5-5.8 per cent.

• Attributes the loss of catch-up opportunities with neighbouring economies to “lack of vision and dynamism” in economic managers and to the socialist obsession with public-sector “commanding heights” that has now made “Disinvestment” the new mantra.

• Documents financial-sector distress: NPAs above Rs. 48,000 crore (over 20 per cent of loan assets), one-third of nationalised banks below 10 per cent Capital Adequacy, “evergreening” of bad loans, and serial scams (1992 securities scam, Urea Scam, M.S. Shoe, CRB Global, Cox & King, Bank of Gujarat).

• Treats Resurgent India Bonds as a costly gimmick: US$4.15 billion mobilised at 12 per cent, only US$3.5 billion brought into India, Rs. 7,500 crore parked back with foreign banks at 9.5 per cent that on-lent at 17.24 per cent for consumer durables — with potential US$8-10 billion repayment burden on India’s external debt.

• Argues Foreign Direct Investment of US$3-5 billion is “peanuts” beside China’s US$30-40 billion, blaming red tape, policy inconsistency, infrastructure gaps and an untouched “live wire” of labour-law reform.

• Defends the Reserve Bank from blanket criticism — “Rajah Vikram had only one ‘Vetal’… Reserve Bank has a score of ‘Vetals’” — while urging that its supervisory function be hived off (per the Narasimham Committee), its relations with Government be “spelt out clearly”, the Governor be given Cabinet-rank status and a permanent Parliamentary Committee oversee its working.

• Reprises the author’s 1986 coinage “Internal Debt Trap”, defining it as the threshold beyond which fresh borrowings cannot cover even debt-servicing charges, and cites the RBI’s 1997-98 Report on Currency and Finance showing the Bank itself absorbed 39.9 per cent of Government’s gross borrowings via devolvement and private placement — evidence India is already operating fiscal policy inside the trap.