India has taken a step closer towards establishing a sovereign wealth fund, by setting up a government-owned offshore company that offers low-cost loans to the nation’s corporates developing infrastructure projects. And debate is mounting in Delhi, whose foreign exchange reserves have surpassed $300 billion in volume, about reserve management.
Finance minister P. Chidambaram told parliament on April 22 that the government has received a proposal – from an expert panel which advises prime minister Manmohan Singh – to set up a vehicle that will invest in foreign companies.
Meanwhile, as a first step towards managing India’s reserves productively, a government-owned offshore company, set up in April, will lend up to $5 billion to Indian companies. The loans may be used by the companies to pay for the import of capital goods for infrastructure projects in India.
India Infrastructure Finance Company Ltd (IIFCL), based in the UK, is preparing to draw a first $250 million tranche of funds from the central bank soon.
Surinder Kohli, managing director of IIFCL India, its parent, told Emerging Markets that Indian companies would find the cost of borrowing from IIFCL “competitive”. The company will get the money at close to the six-month Libor rate, from ten-year government-guaranteed bonds that it will sell to the Reserve Bank of India (RBI), India’s central bank.
The RBI’s investment in the foreign-currency-denominated bonds issued by IIFCL will be held as a foreign currency asset on the RBI’s balance sheet. Essentially, this arrangement permits Indian companies to borrow from India’s forex reserves rather than the market.
India restricts foreign commercial borrowings: Indian companies may only spend the money abroad and an annual ceiling – $22 billion for the year ended March – is imposed. In an interview with Emerging Markets, finance minister P Chidambaram said the rules for foreign borrowings are working quite well and would continue. “As long as they [Indian companies] don’t bring the money into India, it does not create problems for RBI’s monetary management,” he said.
Reserve Bank of India Governor Y. V. Reddy meanwhile warned in an earlier interview with Emerging Markets that India must “consider the risks” involved in setting up a sovereign wealth fund. Unlike most countries that have such funds, it runs persistent current account and fiscal deficits and “does not enjoy the comfort of high earnings from commodity exports”, Reddy said.
“If ‘excess’ foreign exchange reserves are to be managed with a view to maximizing returns, the risk may be taken provided that a separate sovereign institution, not the central bank, takes the responsibility”, Reddy told Emerging Markets. At present India’s foreign exchange reserves are mostly invested in US treasuries and other government bonds.