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Cost of Debt

So, what is the real cost of government debt? Good question.

By Ashish Gupta

Reality: It's payback time

Whether it is the best of times for the Indian economy or not, it just may be the best of times for the Indian government to prepay its high-cost debt. The country's public kitty is overflowing with dollars--nearly $ 82.8 billion, at last count--while interest rates are ruling low in debt markets, both domestic and foreign.

To be fair, the government has not been asleep. In fact, it has been more active than people give it credit for. The government has already decided to prepay a significant part of the sovereign external debt of around $6 billion owed to multilateral lending agencies such as the World Bank and the Asian Development Bank during the current fiscal. This is being done by using cheaper loans contracted at today's more attractive rates.

The government, for instance, was paying 10 per cent interest on loans taken from the World Bank and around 8 per cent on its ADB loans. But today, the government can borrow funds at 3-4 per cent from international markets and 6-7 per cent from domestic markets to prepay the loans--thus saving the difference in interest burden.

According to a senior finance ministry official, $3 billion has already been paid, and another $3 billion will be paid in the course of this financial year. The mechanism is simple. The government raises money from the domestic market and turns it over to the Reserve Bank of India (RBI), which then releases the dollars for prepayment.

That involves a "prepayment penalty'', but is more than offset by the saving. Besides, this is exactly what Finance Minister Jaswant Singh promised in his Budget speech. He made it very clear that the government would continue to take advantage of the comfortable foreign exchange reserves and lower domestic interest rates to prematurely prepay the high cost of currency pool loans of the World Bank and the ADB. That is what he did.

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