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Don't borrow in renminbi, please

S. MURLIDHARAN
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China has retained strong controls chiefly on capital account convertibility of its currency
China has retained strong controls chiefly on capital account convertibility of its currency

It would be dangerous to permit the raising of loans in a currency that is not freely tradable in international financial markets.

There are reports that some of the new entrants planning to source their power plants and equipment from China are also trying to tweak the Indian External Commercial Borrowings regime so they can borrow in the Chinese currency, renminbi, to pay off these suppliers now that the Chinese government has made its currency virtually convertible on current account like the Indian rupee. This is bound to cause disquiet amongst the cognoscenti.

One hopes the government, more specifically the Reserve Bank of India (RBI), does not accede to this request as it can potentially rock the Indian financial boat in the future. Though not explicitly stated in the ECB guidelines, one had always assumed that the freedom to raise money from abroad from varied sources for varied purposes except for investments in the stock market and real estate was restricted to borrowings in hard floating currencies.

Not freely tradable

Maybe it is the fault of the RBI that it has not clearly spelt this out in its guidelines, but it would be dangerous to permit the raising of loans in a currency that is not freely tradable in international financial markets and hence whose present or future value cannot be transparently determined by the market forces. The token, shallow and low volume trade that takes place in the Hong Kong and London currency markets for renminbi can by no stretch of imagination be taken as the equivalent of full-fledged floating of its currency by the Chinese authorities.

The US government can be faulted for cleverly pitch-forking its currency as the international referral currency on the back of an attractive gold exchange standard and reneging from it long ago at the first hint of trouble, but still managing to cling to that status for its currency thanks to the first mover advantage and the TINA factor. However, nobody can seriously accuse it of closing its doors neither to money flowing into its country from abroad nor to money seeking to flow into other countries, one of the implicit conditions for making the grade as a true floating currency. China, in common with India, has retained strong controls, chiefly in the realm of capital account convertibility of its currency and free flow of capital from, and into, its country.

No natural hedge

Allowing ECBs in a currency that is kept under leash, the one that has the potential to appreciate exponentially at the whim of the establishment is fraught with dangers. There is a serious risk of heightened liability at the time of servicing the loan. After all power producers in India are not going to earn their revenue in the Chinese currency so as to enjoy the advantage of natural hedge. One may say that exchange rate risk is an inevitable feature of every borrowing given the fact that not all can enjoy the natural hedge advantage. True, but what makes exposure to non-floating currencies that much more risky is the absence of a free market for them that not only tracks their current fortunes, but the future as well. To be more precise, an Indian company can take a call on hedging its US dollar risks in the light of the current prognosis for the currency as gleaned from the spot and futures market therefor.

No such call can be taken even if an Indian power company taking a renminbi loan wants to. In the absence of a vibrant free market for the currency,it would be constrained to buying renminbi of the requisite quantity each time interest has to be paid or an instalment of the principal has to be paid. And for buying the Chinese currency, it would have to go through the dirigiste drill prescribed by the Chinese ruling establishment and at the price fixed by it. Since the Indian power companies' earnings are going to be in the Indian rupee, the maximum they can do by way of reasonable hedging of their exchange rate risk is to enter into a currency swap agreement with another Indian company exporting to a Chinese buyer, and who is getting paid in renminbi. But that is a long shot. The RBI should allow ECB only in those hard currencies for which there are thriving and vibrant markets as well as players prepared to provide a range of hedging services such as forward cover and currency swap. The renminbi, as it is, is too cocooned and controlled for a foreigner's comfort.

(Note: What was a proposal at the time of writing of the article has been implemented.)

(The author is a Delhi-based chartered accountant.)

(This article was published on September 18, 2011)
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