The Hindu Business Line : Unlocking forex reserves to fund infrastructure

A model that involves the participation of intermediaries such as the World Bank/IMF, the International Finance Corporation, or the Asian Development Bank, could be the key to convincing the Reserve Bank of India to use forex reserves to fund infrastructure projects.

THE MOUNTING foreign exchange reserves even as infrastructure is starved of investment has become as much an embarrassment as having large food-stocks when 300 million people do not have enough to eat.

The Reserve Bank of India (RBI) has the money (the forex reserves) but wants to keep this war chest to keep currency raids or volatility at bay. But lending for infrastructure, as the Planning Commission suggested, entails long payback periods. In any proposed solution, the RBI would prefer to retain a call option on its reserves (wherever and however invested) for which it is prepared to pay a premium (by way of accepting a lesser interest rate than what the actual post facto tenure would have implied). Any solution, for it to become feasible and acceptable to the RBI, should primarily address this legitimate concern.

The solution thus is to find that `intermediary' institution (whose credentials the RBI respects) that takes `liquidity' from the central bank in return for long-term funds to infrastructure projects. The RBI could place, say, $20-25 billion with such intermediaries — may be the World Bank/IMF, the International Finance Corporation, or the Asian Development Bank — with an option to `call' these in one or more lots with a pre-defined `call notice' period. Since the RBI is unlikely to require the entire amount at one go even in a crisis, it could agree to give a graded notice, say, two days for the first 25 per cent, 10 days for a further 25 per cent, one month for the next 25 per cent and so on.

The arrangement should entitle the Government of India (or its nominees) to borrow against these deposits — hopefully at a better interest rate than usual as the loans are backed by reciprocal funds. The entire deposit may not come back as loans, but the Government can raise 75-80 per cent of the RBI's deposits. (If the intermediary agencies lend more than what the RBI places with them, all the better.) The funds should be earmarked for infrastructure investments such as ports, national highways, airports, and railways by the Government or in participatory sector. If the private sector is involved, it could be subject to independent appraisal of both the Government and the funding agencies. In the event of default, the intermediary agencies should have the right of set-off for the amount actually in default. Not all the projects would fail simultaneously. Hence, the RBI's deposits would not get wiped out at once. The Government should then make good the amounts to the RBI against the funds so forfeited due to defaults. Equally the RBI should have a right to take over the loans should the funding agencies fail to honour their commitments.

If there is a crisis-driven withdrawal by the RBI, the loans should automatically be covered by government guarantee to the intermediary agencies and their pricing revised to normal commercial terms, till such time the deposits are restored. There will be a differential between the borrowing rate and the rate at which the RBI would be placing the funds; this is only to be expected given the tenure differential and the country risk rating. But the borrowing rate for the projects so funded may still be cheaper as there is back-up funding. Why would this scheme interest the RBI? Liquidity is preserved (in a crisis, the ability of these agencies to raise resources quickly is far superior to that of the RBI). If the funds are placed with several agencies, chances that all will fail at the same time is remote. Return on its deposits need not be very different given the current actual realised rates. Second, money supply and inflation concerns will be much less compared to when fresh funds are sourced for infrastructure; re-cycling existing reserves would be a far better option for the RBI.

Why would multilateral funding agencies bite this? They are highly bullish on India and are keen to raise their exposure, but India has off late been a `net' re-payer — on some concessional loans even. There is a big supply shortfall (conversely excess demand) in infrastructure and it would take another 10-15 years before the situation gets better — an ideal situation for ensuring demand for the product/service which in turn is ideal for the project lender. .

The Government and the Planning Commission need the funds for infrastructure but are constrained by the fear of pushing up the fiscal deficit. This mechanism could take it out from the fiscal deficit definition (at least, till an amount actually devolves on the government due to project default).

There is no fantasy in this. Is not banking all about intermediation — realigning credit worthiness, liquidity, tenure, lot sizes, etc., — moving those from where they exist to where they are most productively used. Even if the RBI is not interested, it may be possible to work out an arrangement through the private sector. There are enough overseas investors sold on the India story. The private sector has a lot of saleable credit worthiness abroad.

The private sector could be allowed to borrow abroad and invest in participatory notes issued by infrastructure companies for which they could get some reciprocal priority in pricing and usage. Or, it could be set-off against usage of future services by investors at some pre-decided prices.For infrastructure projects the related notes could be guaranteed by the government, , which could hold the assets in return for the guarantee. To solve the problem of excess reserves multilateral agencies could be allowed to borrow in Indian markets. And their bonds given SLR status to a limited extent. That will give banks some choice, provide liquidity, and help them manage forex risks. This will soak up dollars to the extent of these agencies' net borrowings in the Indian market. This would help the RBI even if it does not do much for infrastructure.

Need for `Reserve bonds'

For the borrowers (of external commercial borrowings, foreign currency convertible bonds, or even ADR and GDR issuers) it makes sense to borrow abroad at 5 per cent to repay their loans at 7 per cent and 9 per cent and thus make money. But when this money does not get absorbed in imports — project or raw materials — the RBI is forced to deploy it at 2 per cent (or such low yields). The gap of 3 per cent is definitely a loss to the country. The loss will have to be shared by the borrower, the RBI, the interest earners and the nation. How much each will bear is a question of percolation based on several factors such as the interest rate, the forward premium, the inflation rate, and so on. But since the benefits of borrowing abroad to repay costlier existing loans accrue exclusively to the foreign currency borrower, the resultant costs should also be loaded on them. It is unfair to let them load others or the system. Besides fairness, with misaligned incentive structures one is in serious danger of aggravating the problem further without check.

The RBI can issue special bonds to those who bring foreign money much before they need it, covering the portion that is not immediately needed or a portion of it. On this it should pay the same rate as it earns on its reserve moneys parked abroad, say, 2 per cent. When the corporate needs the forex, it should be able to surrender or redeem these bonds for the forex along with any accumulated interest. Thus, the entire loss on reserves during the period of mismatch will get loaded on the borrower instead of punishing others such as the RBI, the interest earners, the export earners (who suffer because of currency appreciation), and so on. It may even be made tradable in which case they will trade for less than parity (due to excess supply) and the lesser price of bonds will ensure that the loss gets loaded on the borrowers directly.

(The author is with Atul Limited. The views are personal. Feedback may be sent to swaksha_ad1@sancharnet.in)

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