To build the Mumbai–Ahmedabad high speed rail project, Japan has provided India a 50-year loan of Rs 88,000 crore to finance the project at a 0.1% interest rate and 15-year lock-in period.
A recent article titled “How the Japanese Loan for India’s Bullet Train is a Rip Off”, by Bishwajit Bhattacharyya has suggested that the Japanese loan for the Ahmedabad-Mumbai bullet train is far from being “almost free”.
The article’s key argument is that historically, the Indian rupee (INR) has depreciated against the Japanese yen (JPY) and that based on this logic, it can be deduced that India will end up paying a multiple of the actual principal amount. As per the article, the rupee’s purchasing power declined from 19.77 JPY to 1.72 between 1985 and 2017. The article seems to suggest that the trend is expected to continue over the next few decades. Based on this currency movement, India may end up paying Rs 3,00,000 crore for a Rs 88,000 crore loan.
The argument – based on the assumption that since the JPY has appreciated against the INR over the past few decades, it is likely that the same trend will continue – falls short on its own turf of what it calls “cold calculations”.
There are four reasons why this portrait may be unduly pessimistic.
First, any comparison of exchange rates and their consequent impact on corresponding economies should be based on real exchange rates and not nominal exchange rates. Real exchange rates are nominal exchange rates adjusted for the inflation in a country’s economy. The article under discussion has based its entire argument on how many JPY a single INR has been able to buy over the last few years – thus using the nominal exchange rate. However, the true extent of the exchange rate impact can only be studied if it is adjusted for inflation – which varies greatly based on countries’ stage of development.
The following two figures will illustrate this point. The first graph compares nominal effective exchange rate (NEER) from Bank of International Settlements (BIS) data. The exhibit validates Bhattacharya’s view that on the NEER basis, the JPY has been appreciating when compared to the INR.
However, the second graph has a different story to tell. It compares the real effective exchange rate (REER). As per this, the INR has been appreciating steadily – in particular from the mid-2000s. Thus, even if nominally the INR can purchase less JPY, after adjusting for inflation in real terms, the rupee’s ability to purchase yen has been increasing. This differentiation between nominal and real exchange rate punches a hole in the thesis that the Indian currency will continue to purchase less yen in real terms.
Second, is this currency appreciation expected to continue for the foreseeable future? The answer is an emphatic ‘yes’. On exchange rates, the broader understanding in macroeconomics is that as long as there are net productivity gains in any economy, its real effective exchange rate will to continue to appreciate against other currencies.
The third graph below – showing the REER of three major economies, US, China and Japan – illustrates this point further. Two incidents show how productivity growth partly plays a critical role in how a country’s currency performs over time. First, Japan’s lost decade of 1990s – a decade of major economic slowdown was characterised by slowdown in productivity. This slowdown began in the early 1990s and we can see how the JPY steadily depreciated compared to the USD – a country it was competing against fiercely until the late 1980s. Second, China continues to build on its productivity growth since the 1990s and as the US slowed down around the period of the global financial crisis (2008-09), China’s currency sharply accelerated in comparison to the USD. This indicates that the productivity growth slowdown in the US, among other factors, played a role in its currency depreciation.
Thus, as productivity tapers, the exchange rate of developing countries catches up with their developed counterparts. Along these lines, it can be safely assumed, barring exceptional technological disruptions, that the Indian currency will continue to appreciate against the JPY on the back of continued and robust productivity growth.
Third, Bhattacharya claims that since 10-year Japanese government bond yields of 0.04% are much lower than the 0.1% interest on the loan, India has itself a poor bargain. The counter-view to this argument is that the notion of loss depends on the vantage point. India’s 10 year government bond yield is currently 7%. Thus, if India had to source the loan from within the country or any other sovereign pension funds – it would have been paying out a much larger amount. However, India is paying interest of 0.1% to the Japanese. Let us not assume that such project financing is a zero-sum game wherein if a country is making any money then the deal is sour. Instead we should focus on how this is a big arbitrage gain, how we are being charged a low investment risk mark-up and how governments are answerable to their local constituencies. In the process they need to show that they will also make some money, however less it maybe.
Fourth, macroeconomic stability is also a key ingredient of currency exchange rates. After more than two decades, India has a government with an absolute majority in the lower house of parliament and is on its way to gain a majority in the upper house. Further, given India’s vibrant technological innovation ecosystem, robust capital inflows, and large share of under-35 population against Japan’s ageing and diminishing population and low acceptance of migrants, it is likely that in coming decades, India’s productivity will inch closer to Japan’s and thereby, in real terms the INR will appreciate against the JPY.
Based on the above arguments, one can conclude that the notion of India paying more than Rs 3,00,000 crore for an Rs 88,000 crore loan is flawed since in real terms, India’s currency will likely continue to appreciate against JPY. Also, against the other options which could have funded this project, India has got for itself a very sweet deal by any standard.
Therefore, one can easily conclude that the economic reality of this deal isn’t too far from the political rhetoric.