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Some Thoughts on Debt: The Indian Case

Posted by Alex M Thomas on 30th April 2014

Any entity, private or public, needs to borrow if its expenditure exceeds its income. The difference between expenditure and income will then be the volume of debt. This post discusses the following: the meaning and role of debt, a brief overview of various kinds of debt, the fundamental difference between private and public debt, the structure of the Indian debt market, corporate debt and government debt in India. The post ends with some reflections and suggestions.

It is public or government debt which receives maximum attention in the media and rightly so.  Some of the other kinds of debt are external debt (the proportion of a country’s debt borrowed from foreign lenders), household debt and corporate debt. Households borrow money in order to meet various needs such as the purchase of assets, for purposes of education, for medical expenses, etc. Corporate debt refers to the excess of expenditure over income which is financed through borrowing (via issuance of bonds and debentures) by the private non-bank sector. In India, besides these different kinds of debt, agricultural indebtedness has received significant attention from academics, policy makers and political agents. A market for credit is important not just for long-term asset purchases or constructing plants but it is also important for daily business transactions, and today, also for usual consumption needs. One needs only to look at the booming credit card industry for confirmation.

There is an overwhelming tendency to impose rules of finance employed by households on the government. This is fallacious. As individuals, we try to live within our means; we borrow reluctantly. Agricultural farmers, industrial firms and service providers need to borrow too. For, it is unlikely that every person who wants to start an enterprise will possess the required funds. If that were so, the meaning of entrepreneurship would have been different from what we know it to be. Similarly, for a government (central, state or local), which is expected to conduct policies which have social and environmental benefits, it becomes necessary to borrow. Taxation incomes are seldom sufficient to meet the recurring and capital expenditure of the government. Moreover, social programmes relating to education, employment, environment, food and health have very long gestation periods. The point is that government bodies (Ministry of Consumer Affairs, Food and Public Distribution, Ministry of Agriculture and Ministry of Drinking Water Supply and Sanitation to name a few) are not profit-maximizing bodies; but, this does not imply that they can be inefficient or irresponsible. By virtue of the fact that they are democratic bodies and because their incomes and borrowing are mainly from households (the voters), it is imperative that their functioning is transparent and organizationally efficient. Government borrowing or public debt is not, or rather, should not be, synonymous with organizational inefficiency.

The sovereign debt in India is issued by the Central and State government. The instruments include Treasury bills, Index bonds and zero coupon bonds. Government agencies, public sector undertakings (PSUs) and government owned banks issue debt instruments – bonds, debentures, commercial paper (CP) and certificate of deposit (CD). The private sector comprising the non-bank corporate sector and private sector banks issue bonds, debentures, CPs and CDs. In advanced economies, the debt market is the preferred route for raising funds. However, in India, the equity market is more preferred than the debt market, and government securities dominate the Indian debt market. [For more details, see the 2004 SEBI working paper no. 9 titled ‘Corporate Debt Market in India: Key Issues and Some Policy Recommendations’. Conditions are changing and more corporate debt is being issued, as a more recent (2013) CRISIL document indicates.]

A 2013 Credit Suisse report on India’s financial sector pointed out the high growth in the debt levels of ten corporate groups – Lanco, Reliance ADA, GVK, Jaypee, Adani Enterprise, Essar, GMR, KSW and Vedanta. Despite profitability pressures, their debt levels rose between 2012 and 2013. Also, 40-70% of the loans are foreign currency denominated. Delays in their planned projects can cause further strain on their cash flows and therefore on their debt servicing ability. Some of them have undertaken asset sales, but they have proved insufficient. Indian banks need to be concerned as well; although, majority of the non-performing assets (NPAs) are from agriculture and small & medium enterprises (SMEs). In 2014, the International Monetary Fund sounded a warning too.

The debt-to-GDP ratio is more important than debt levels themselves. Why is this so? This is because an economy whose GDP is growing faster than its growth in debt will not face the problem of repayment. However, if the GDP grows at a smaller pace than debt growth, the economy will not have adequate surplus (aggregate output net of replacement) to repay the debt. This is what we mean by debt sustainability. In early 2014, the credit rating agency, Moody’s warned that India’s sovereign rating can be affected due to the slowdown in growth and high inflation. [In so far as public authorities, via the central bank, can create money ex nihilo, debt can always be repaid (referred to as monetising the debt). However, this is the case if and only if the public debt is denominated in the local currency. In India, most of the public debt accrues to Indians and is therefore denominated in Rupees.] The following chart compares debt-to-GDP ratio of India with three advanced economies – Australia, UK and US.

 

Data from World Bank

Clearly, advanced economies have different debt-to-GDP ratios (also see this link for data on OECD countries). In short, there is no economic reason why a high debt-to-GDP ratio is bad for the economy; it is the growth in the debt-to-GDP ratio that must be closely monitored and appropriate measures undertaken to ensure that the economy grows at a faster pace than the growth in debt. As previously noted, government expenditure on education, environment and health have long-term positive benefits (significant positive externalities). Over time, these expenditures will boost economic growth and will therefore aid in debt repayments. Of course, the returns from any investment – private or public, depend on the effectiveness of the project undertaken such that they generate the expected yields.

The financial liabilities of the household sector have also risen over time, due to the attractive home loans and increased ease of obtaining credit cards. All economic agents – be it households, corporate bodies or the government, often (and have to) resort to borrowing. This post has shown that the borrowings undertaken by the Indian household sector, the Indian corporate sector and the Indian government have grown over the years. This, per se, is, and should not be a cause of immediate concern. However, this does warrant a more detailed analysis of the ability of the Indian government to make debt repayments, which hinge crucially on the rate at which the Indian economy grows and its rate of inflation. A serious macroeconomic analysis, perhaps based on the economics of Domar, Keynes and Lerner is in order.

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Posted in Economic Growth, Economics, GDP, Government, India, Keynes, Macroeconomics | No Comments »

Robert Torrens: An Introduction

Posted by Alex M Thomas on 30th September 2013

Robert Torrens’s An Essay on the Production of Wealth (1821) is an important contribution to economic theory, in particular, to classical economic theory. Torrens was involved in the founding of the London Political Economy Club along with James Mill, David Ricardo, Thomas Tooke and others. Torrens has written extensively on monetary issues, on colonisation and on price theory. He is also credited with having discovered the comparative costs principle independently of Ricardo. This blog post focuses on his contributions to the theory of value and the possibility of a general glut in his debate with Ricardo.

Torrens is one of the very few (to be precise, nine) economists mentioned by Piero Sraffa in his Production of Commodities by Means of Commodities; Sraffa approvingly cites him for his method of treating fixed capital. Fixed capital is conceptualised as a distinct commodity (a joint product) alongside new commodities which emerge from the production process. Torrens utilises a theory of value based on ‘capital’ as opposed to Ricardo’s labour theory of value. But, how is ‘capital’ to be measured without the knowledge of values/prices? Ricardo recognises that when labour-capital ratios are not uniform across sectors, value will not be proportional to the embodied labour. And, as Carlo Benetti writes in his entry on Torrens in The Elgar Companion to Classical Economics, when the rate of profit is zero, the labour theory of value holds; however, the existence of positive profits does not per se invalidate Ricardo’s labour theory of value. A satisfactory resolution of this problem in value theory is to be found in Sraffa’s simultaneous determination of profits and prices.

The macroeconomics of Torrens, built on his theory of value and distribution, suggests the possibility of a general glut in the economy. On general gluts, Torrens writes: ‘a glut of a particular commodity may occasion a general stagnation, and lead to a suspension of production, not merely of the commodity which first exists in excess, but of all other commodities brought to the market’ (Torrens 1821: 414; as quoted in the Benetti entry on page 473). The underlying reason for this is a disproportion between the different sectors of the economy. Owing to the structural interdependence prevalent in an economy, a disproportion can lead to a fall in ‘effectual demand’. This will lead to a glut in commodities in that particular sector and in other sectors as a consequence of a fall in sales and incomes in that sector. This, evidently, is in direct contrast with Say’s law, loosely understood as – supply creates its own demand.

Other notable commentators on Torrens include Giancarlo DeVivo and Lionel Robbins. The latter published his work in 1958 entitled Robert Torrens and the Evolution of Classical Economics. In 2000, DeVivo edited and put together the Collected Works of Robert Torrens. Studying Torrens will certainly prove invaluable in gaining a deeper understanding of classical economics, and especially his views on general gluts might have contemporary use in relation to the economics of Keynes and Kalecki.

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Posted in Classical Economics, Classical Political Economy, David Ricardo, Economic Thought, Economics, History of Economic Thought, Keynes, Macroeconomics, Michal Kalecki, Sraffa | No Comments »

A Foreword to Keynes’s General Theory

Posted by Alex M Thomas on 5th September 2012

Published in 1936, The General Theory of Employment Interest and Money remains a valuable book for both economists and policy makers. The recent financial crisis and the ongoing economic crisis have revived popular interest in this 1936 classic. The year 2009 saw the publication of two concise books on Keynes by two eminent scholars, Skidelsky and Clarke; an earlier blog post reviewed both their works. Not much will be said about the author – John Maynard Keynes, in the following paragraphs. The main objective of this blog post, as the title suggests, is to provide a foreword to The General Theory. By foreword, we mean the following: ‘The introduction to a literary work, usually stating its subject, purpose, scope, method, etc.’ (Oxford English Dictionary).

The rapidly expanding market for economics textbooks has, to a significant extent, substituted the reading of original works. In this environment, where our understanding of Keynes is based upon what Blanchard, Branson, Mankiw or Romer write, the following blog post strives to remain faithful to Keynes unlike the IS-LM version of Keynes proposed by Hicks and popularised by these textbooks. Keynes labelled Ricardo, Marshall and Pigou as Classical economists; this definition is not adhered to in the present blog post for Classical economics is a system of economic theory (to which Ricardo belongs) which is distinct from and a rival to Marginalist economics of which Marshall and Pigou are important members (see Thomas 2011 for more).

For Marshall, Pigou and marginalist economists of today, unemployment is a transitory phenomenon caused by ‘imperfections’ in the operation of the market forces. In their theoretical world characterised by competition, full employment is the ‘general’ case. However, Keynes demonstrated that this notion was based on assumptions contrary to the real world such as flexibility of money wages, absence of store of value function of money and rate of interest as a real phenomenon capable of equilibrating savings and investment and hence can only be considered a ‘special’ case. As he writes, ‘there has been a fundamental misunderstanding of how in this respect the economy in which we live actually works’ (p. 13). Opposed to this state of affairs, Keynes argued that the ‘general’ situation in an economy with competitive markets is the prevalence on unemployment. In other words, the central purpose of Keynes’s work is to demonstrate that unemployment is the usual situation in a competitive economy.

The main subject matter of The General Theory is the determination of aggregate employment and income or ‘the theory of output as a whole’ (Preface, p. vi). This needs to be seen against the then prevalent mode of economic analysis which was largely Marshallian in nature. Marginal productivity theory along with the principle of substitution was employed to understand the allocation of a given level of output; under conditions of competition, in equilibrium, full employment was (and still is) expected to prevail. And questions concerning the determination of the level of output were carried out within a theory whose primary subject matter was allocation, and not determination, of output levels. (On this, see especially Keynes’s preface to the German edition of his 1936 book.)

Marginalist economics, in the 1900s, looked up to the works of Marshall, and Pigou.  Keynes was brought up on a large dose of their works. Theories of production concentrated on determining the output levels in individual markets, and more often on allocation of output. Similarly, theories of distribution examined the allocation of income to workers and capitalists. Policy recommendations were made on the basis of such theories. The remedy to unemployment, according to Pigou and other orthodox economists, consisted in lowering workers’ wages. Economics certainly did not have an apparatus or a framework to study the ‘level of output as a whole’, or macroeconomics as it is called today. Besides output levels, Keynes also stressed the role played by money in ‘real’ analysis – the examination of income, employment, investment, consumption and saving. Rate of interest, according to Keynes, is a monetary phenomenon which depends on liquid preference. In short, the scope of his work remained the same as that of earlier economists – the study of wealth. Today, economics has broadened its scope to include any subject which can be examined by employing some form of the cost-benefit analysis. (See Malthus: The Scope of Political Economy)

Being brought up in the marginalist Marshallian tradition, Keynes attempted to completely break away from their method. In the preface to the German edition, he makes his desire explicit: ‘It was in this [Marshallian] atmosphere that I was brought up. I taught these doctrines myself and it is only within the last decade that I have been conscious of their insufficiency. In my own thought and development, therefore, this book represents a reaction, a transition away from the English classical (or orthodox) tradition.’ However, his attempt was not entirely successful. This is especially visible in his analysis of investment, where he develops the ‘marginal efficiency of capital’; much has been written on this in the context of the capital theory debates. The role he assigned to ‘expectations’ and the links to investment levels have been considered an improvement of the economists’ toolkit and consequently seen as an improvement in the capacity of economic theory to understand reality.

The aim of this blog post has been mainly to put The General Theory in the 1936 context, where Marshallian economics reigned supreme. Today, central governments, central banks and policy makers employ macroeconomic theory to understand the real world and to frame policies which increase output levels, stabilise prices and ensure financial stability. However, majority of these theories remain rooted in the orthodox tradition (variants of Marshall, Walras, Pigou and others resurface in the form of DSGE, New Classical macroeconomics or New Keynesian macroeconomics) which Keynes broke away from. Truly, The General Theory published in 1936 remains an economics classic, which is of enduring value to those who find terrible problems with the current orthodoxy!

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Posted in Economic Thought, Economics, Employment, Keynes, Macroeconomics, Malthus, Marginalist economics, Neoclassical Economics | 3 Comments »

Malthus: The Scope of Political Economy

Posted by Alex M Thomas on 1st April 2012

In these difficult times we live in, what economics needs is perhaps, depth and not breadth. Unemployment, poverty, inflation, food insecurity, financial fragility, debt crisis, etc can be better understood and tackled by diverting increased resources (time and financial) in understanding the production, distribution, exchange and consumption of wealth. This blog post very briefly examines Thomas Malthus’s (1766-1834) view of political economy – its method, scope, uses and limitations.  For this purpose, I have used John Pullen’s definitive variorum edition of Malthus’s Principles of Political Economy published as 2 volumes by Cambridge University Press in 1990.

According to the Cambridge Advanced Learners Dictionary, ‘scope’ is defined as the ‘range of subjects covered’. In the context of political economy, scope refers to the range of subjects it covers. That is, the scope of political economy informs us about the sphere of analysis, the boundaries or limits, the kind of situations it describes and its applicability in the real world or, its relevance. Keeping in mind that mathematics played only a small role in political economy during Malthus’s time, let us see what his view of political economy is: ‘the science of political economy bears a nearer resemblance to the science of morals and politics that to that of mathematics’ (p. 2). Undoubtedly, morals played and still play an important role for interventions in the economy based on what we consider to be a ‘good society or economy’. And politics, distributional conflicts over income, land, natural resources and employment are integral part of any economy. Thus, it is important that political economy (and economics) takes into account these distributional conflicts when theorising or modelling an economy. However, for purposes of theory, these conflicts can be taken as given from outside economics (exogenous) or can be determined within economics, in the manner of behavioural economics.

It would not have mattered if political economy was/is not a very important branch of knowledge. Reminiscent of Keynes’s words, Malthus writes: ‘The science of political economy is essentially practical and applicable to the common business of human life. There are few branches of human knowledge where false views may do more harm, or just views more good’ (p. 12). But, Malthus wrote it more than a century earlier. (See also Sismondi’s words of a similar nature). Since Malthus viewed political economy to have significant practical applications, the complete title of his book reads ‘Principles of Political Economy Considered with a View to their Practical Application’. The editor, Pullen, gives us a bit more information on this matter. ‘This was apparently a lifelong concern. As a student at Cambridge in 1786 Malthus wrote to his father: ‘I am by no means, however, inclined to get forward without wishing to see the use and application of what I read. On the contrary I am rather remarked in college for talking of what actually exists in nature, or may be put to real practical use’’ (p. 291, Vol II; all other page numbers excepting this refer to Vol I).

Malthus understands that ‘To trace distinctly the operations of that circle of causes and effects in political economy which are acting and re-acting on each other, so as to foresee their results, and lay down general rules accordingly, is, in many cases, a task of very great difficulty’ (p. 12). Economic processes are caused by a multiplicity of causes and often not by a single one. Owing to this and because of his view of economics as a practical science, he maintained that ‘[t]o know what can be done, and how to do it, is, beyond a doubt, the most valuable species of information. The next to it is, to know what cannot be done, and why we cannot do it’ (p. 17). In other words, we must be very aware of the ‘scope’ of our knowledge.

Furthermore, if our objective is to understand the problems of unemployment and poverty, we must perhaps, as mentioned in the introduction, study in-depth the process of generation and distribution of wealth. I conclude with a statement by Malthus: ‘If we wish to attain anything like precision in our inquiries, when we treat of wealth, we must narrow the field of inquiry, and draw some line, which will leave us only those objects, the increase or decrease of which is capable of being estimated with more accuracy’ (pp. 27-8).

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Posted in Behavioral Economics, Classical Economics, Classical Political Economy, Economic Thought, Economics, History of Economic Thought, Keynes, Malthus, Thomas Malthus | 5 Comments »