If inflation is the 'holy cow' of economic growth, then foreign exchange reserves are surely the 'holy goat'. And using forex reserves for infrastructure seems to have got many an economist's goat.
Ever since Montek Singh Ahluwalia broached this "out-of-the-box" idea in 2004, think-tankers have produced an array of facial expressions ranging from raised eye-brows, sardonic grins and puckered lips. Since Budget Day 2007, when the finance minister announced some specific schemes to move ahead on using forex-for-infra (backed by recommendations from the Deepak Parekh Committee Report), the quizzical looks have been gradually replaced with bemused wonderment that this idea may actually have a fighting chance of getting implemented soon.
What is the idea?
The finance ministry is apparently considering setting up two wholly-owned foreign subsidiaries of the Indian Infrastructure Finance Company Limited (IIFCL), itself wholly owned by the Government of India. One of the subsidiaries will guarantee the fund-raising activities of SPVs (of public sector firms or PPPs) seeking to raise money abroad. The other subsidiary will lend the forex it will borrow from RBI to infrastructure initiatives that are seeking to import capital goods or meet their need for external borrowings.
Why do most economists hate the idea?
Here's a shot at listing eleven reasons why "those forex reserves should be left alone":
- A key objective of forex reserves is for the central bank to manage India's monetary policy, to keep exchange rates stable and in times of crises to defend the rupee. As India gets increasingly plugged into the global economy, it will be difficult to predict how big a war chest it will actually need in a financial crisis. So while it may appear that $196 billion in reserves is a lot of money idling away, it should be touched only as a last resort. (Remember shipping gold to the Bank of England in 1991!)
- It undermines the RBI's autonomy as the sole arbiter on the use of forex reserves. The quality of governance in any democracy improves with the independence of its institutions. The RBI must be free to manage monetary policy, without undue interference from the executive.
- Using the India Infrastructure Finance Company Limited (IIFCL), which is wholly owned by the government, to borrow foreign currency from the RBI would raise overall government liability.
- Most infrastructure inputs are not imported.
- Using reserves as collateral for borrowing abroad is equivalent to currency appreciation through the back door.
- Using this mechanism for 'credit guarantee' tantamounts to a straight-forward 'sovereign guarantee' through a convoluted process.
- It is nothing other than deficit financing through stealth and obfuscation.
- The private sector has clearly demonstrated its ability to borrow abroad without any crutches. India Inc is finding it cheaper to borrow abroad to fund domestic expansion plans, particularly in the context of the rising interest rate regime at home. Commercial borrowings from global sources have risen to $35.98 billion in December 2006.
- Where there is a clear business model, a la telecom or civil aviation, the lack of ability to borrow abroad has not been a show-stopper.
- A large number of infrastructure organisations are not considered creditworthy. The deployment of forex reserves -- no matter how small a proportion -- is too risky a proposition.
- India's reserves have a far higher proportion of portfolio investments, that are by their very nature, hugely susceptible to flowing out.
But surely all these reasons have been considered, debated and chewed upon by our wise men who are line managers of our economy? Messrs Prime Minister, Finance Minister, Deputy Chairman Planning Commission and Deepak Parekh appear to have agreed that on balance of consideration, the idea may well worth be pursuing.
Let us now look at the reasons that support the idea.
- The issue of risk is not very large. It is understood that only about $7 billion is being considered for this purpose out of the $196 billion forex reserves. So, 3.6 per cent is a risk worth taking if there is a fair chance of impacting India's infrastructure development positively.
- India needs to find $70 billion every year in the Eleventh Plan period. This $7 billion certainly helps.
- Most of the country's current forex is parked in deposits and securities of central banks around the world -- mainly the US Fed. In 2005-06, the return on forex assets was 3.9 per cent and in the year before that, it was 3.1 per cent. Surely they could be used more effectively or profitably? What better than 'nation-building' that also potentially earns higher returns?
- The downside of money-supply increase domestically does not exist. Foreign exchange borrowed from the RBI will be used to fund the import of capital equipment, thereby having a neutral impact on the rupee. As of now, ECBs raised by domestic companies have an inflationary impact since a part of the foreign borrowings are converted to Indian rupees before being utilised within the country, thereby increasing the money supply in the economy.
- IIFCL's credit guarantee company would borrow from the RBI and invest in highly-rated collateral securities. It would then provide a 'credit wrap' that will enable Indian companies borrowing abroad to secure cheaper and longer tenure funds.
- The scheme has, for inspiration, the Government of Singapore Investment Corporation (GIC). GIC was floated in 1981 as a private company wholly owned by the government and was meant to manage forex reserves. GIC, which invests about half of its assets in equity, manages over $100 billion today. Its investments include a 2.29 per cent stake in ICICI Bank.
- Using forex reserves for infrastructure also appears to be gaining momentum at the regional level. A recent study by Research & Information Systems for Developing Countries (RIS), assisted by UNESCAP, has pitched for a Regional SPV for infrastructure financing. The Regional SPV would fund infrastructure in Asian countries and could be created by earmarking 10 per cent of the $3 trillion regional forex reserves.
Looking at both sides of the argument, there appears to be a case for giving the forex-for-infra goat the chance to morph into a dollar-denominated biryani. If it fails to impact, then at least it would have been a worthwhile sacrificial offering at the altar of a fresh and bold idea.
Let's go for it!
The writer is the Chairman of Feedback Ventures. He is also the Chairman of CII's National Council on Infrastructure. The views expressed are personal.