RBI's challenge - balancing currency and debt

Image source: www.novinite.comEven while India tries to garner more NRI deposits to stabilise its currency, it is faced with a commensurate increase in external debt. At a time when GDP growth has slowed down significantly and external debt will likely rise, external debt sustainability is worth watching out for. 

Source: Ministry of Finance, Government of India

In a bid to stabilise the sharply depreciating Indian rupee, the RBI announced measures to garner Non Resident Indian (NRI) deposits last week. While a sharp policy move was required to ensure stability of currency, the next challenge for the RBI is ensuring a balance between holding up the rupee and keeping India's external debt in check.

According to numbers from the Ministry of Finance, India's external debt in 2012-13 was at around US $ 390 billion in, an increase of around 13% from the corresponding period of the previous year. This is partially on account of increase in NRI deposits, among other factors.

Technically, the absolute size of the external debt is less relevant, as long as the economy is large enough to sustain it. A common measure of measuring debt sustainability is the External Debt to GDP ratio, or the proportion of borrowings to the total income of an economy.

For India this ratio has been on the rise over the past two years, partly on account of the overall increase in debt and partly on account of the fact that India's economic growth has been slowing down. From the chart, it is evident that debt has been rising overtime since 1991 every year, except in 2009, when it fell slightly from the previous year. Of course, India has not been able to sustain its previous economic growth, which is part of the reason for the deterioration in the ratio.

If the worst of India's economic slump is behind us, we might see some turn around in the figure, even as more debt is garnered to sustain the currency and the CAD. Nevertheless, the ratio is a figure the policy makers should be keeping an eye on.

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