By Kala Rao
In his budget speech in February, Indian finance minister P Chidambaram announced that the government had decided to use a portion of India’s abundant foreign exchange reserves to fund infrastructure projects. The idea, first mooted about three years ago, was abandoned after economists roundly condemned it as deficit financing by another name. Now, it appears that the government has changed its mind.
India’s foreign exchange reserves crossed $200 billion in early April - the fifth largest stock among all emerging economies - and well over the country’s total external debt of around $142 billion, giving the country adequate protection against external shocks. The build-up of forex reserves, a result of large capital inflows into the country and the central bank’s interventions in the currency market to sterilize those inflows, has prompted concern over whether the reserves could be put to better use than they are now: mostly invested in US Treasuries and other foreign assets.
A panel of top bankers led by Deepak Parekh, Chairman of HDFC (a large mortgage lender), set up to study ways to finance the infrastructure sector, noted in a report put out in February that “there is a need to find suitable structures that can help in channelling these [forex] reserves for investments in infrastructure projects without [running] the risk of monetary expansion.” ICICI Bank deputy managing director Chanda Kochhar, a member of the panel, says, “Given the current concern over inflation, the panel has proposed two ways in which forex reserves may be used for infrastructure without adding to domestic liquidity.”
Alternatives
The first is to set up a government-owned company offshore that will invest in infrastructure assets overseas, such as a power project or an oil refinery in a foreign country or an international gas pipeline that will supply energy to India. It could also help Indian gas and oil companies to acquire oil fields or gas reserves abroad. The second way is to use the forex reserves to subscribe to long-term foreign currency bonds issued by a credit insurance company set up by the Indian government overseas, which will provide credit guarantee or enhancement for a fee to borrowers in India who wish to raise capital from the international markets.
Not everyone is sure this will work. “The reserves should be available to anyone, even those in the private sector who want to make overseas investments,” says Vijay Kelkar, a former adviser to the minister of finance. Others have voiced similar doubts that, if the investment decisions are left to the government or the public-sector oil and gas companies, they may not be sound economic ones.
In any event, the government would have to decide how the reserves are to be transferred from the central bank to either the government’s balance sheet or to an overseas investment company that is set up. According to Reserve Bank of India governor YV Reddy, from the central bank’s point of view, the transfer of reserves must be transparent and at a price which is economically defensible.
“Allowing Indian companies to invest more overseas is an efficient way to use our foreign exchange reserves,” Reddy tells Emerging Markets. “In the absence of such investment, those dollars would have added to our forex reserves.
“Our companies require size and domain knowledge, and one way to acquire this is by acquiring companies. Also, the fact that international capital markets are prepared to fund Indian companies shows their confidence in our companies, so one can be sure of a reasonable commercial return. We prefer such capital outflows through the real sector rather than through the financial sector.”