The Hindu Business Line : Using forex reserves for funding infrastructure

Forex reserves virtually make up the Reserve Bank of India's entire assets. From a position of shipping gold to London to borrow a few millions to the $200-billion reserves today, it has been a remarkable journey. A debate on making funds available for infrastructure projects has ensued.

To sustain the booming economy there is need for huge investments in infrastructure, but the prospects of rationing of funds and increased costs would act as a dampener. When scarce resources have to be deployed judiciously, some selectivity and rationing are inevitable. Though costlier, opening the LAF or repos window by the RBI would lead to more efficient use of resources. Using borrowed funds would also mean stringent scrutiny of their application.

A reduction in CRR amounts to releasing the banks' own funds across the board. A percentage point reduction in CRR can inject as much as Rs 26,000 crore in to the system. As an alternative can RBI bring back some of the reserves to ease the position?

The RBI buys most forex inflows, both on capital and current account, to ensure an orderly market and also build-up international investors' confidence. It has helped the country's exports too by keeping the rupee rise under check

These funds, if used in domestic markets, would inject liquidity into the market a second time and can create inflationary pressures. Off-loading huge forex funds could further strengthen the rupee, upsetting the exchange rate equilibrium and aggravating concerns of the exporters. To insulate the markets, once again, the RBI only has to suck out the dollars/euros, the reserves position reverting to square one. In effect, it amounts to the RBI pumping rupees into the markets with all its attendant consequences.

Apart from lower yields on reserves, an appreciating rupee means depreciation of reserves. The RBI, thus, finds itself in an unenviable position. Those looking to push the infrastructure projects such as roads, ports, airports, railways, power and irrigation eye the billions, thanks to the publication of the reserves and the media glare.

The funds would become available if the RBI decides on lending this money either to the Government, commercial banks or directly to private enterprises. The Government need not borrow in foreign exchange as its borrowings are not new and the forex reserves are not a windfall or newfound treasure.

As part of the economic reforms, monetisation of deficit has been put an end to. Government borrowings now have to be at market rates. In the past, the markets and to some extent the RBI, helped the Government in raising resources at relatively low coupons. With the credit off-take being poor the banks too put more money in securities than required by law.

The Government lured the banks looking to take care of the NPA provisioning requirements, with their buyback /switch of high coupon securities by offering tax incentives. In the recent tight money market conditions, the banks, in fact, were compelled to shed some of the securities booking losses, causing depreciation of their holdings and necessitating further provisions The GOI has been signalling to the market that rates would be reigned-in and they would not like a hike in the coupon.

The RBI has been assiduously monitoring and managing the money supply through measures like leveraging the `repo rate'. It can't permit government borrowings beyond the planned limit as even lending from the forex reserves could impact the money supply. The Government's dilemma too is that injecting a few billions of dollars into the economy can negate the efforts in containing inflation, leading to a cascading effect.

There has been a clamour from borrowers for foreign currency denominated lending to take advantage of the low interest rates and the stable or favourable rupee. Banks couldn't meet the demand for want of funds. NRI deposit accretion has been tardy because of a cap on rates imposed by the RBI, as a part of its efforts to contain the inflow of funds.

Markets would be happy if the RBI decides on opening the tap now. Banks did approach the RBI in the past for a line in dollars but the central bank rejected the idea, fearing dilution of its monetary policy.

At one time, the RBI even did not keep even a part of its reserves with Indian banks abroad, as the amounts did not count for reserves. Now the scenario has undergone a sea change. If the RBI decides to lighten its kitty without impacting the money supply and exchange rates the best option would be to fund only the import/forex requirements of projects. The funds can be routed through the commercial banks subjecting the investments to viability scrutiny. To overcome the inhibitions on using reserves to lend for projects, a forex refinance window of the RBI can be opened.

(The author is a former Managing Director of State Bank of Mysore and is accessible at murthy@mandavilli.com)

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