Fire-fighting

The foreign exchange market does not seem to be very impressed by the five-point package of measures announced by the Centre to arrest widening Current Account Deficit (CAD). After pulling back from its record low vis-à-vis the dollar last Friday, the rupee resumed its southward journey by sinking below 72.5 this week. The market’s response is unsurprising. While this package of measures tries to bolster dollar inflows by rendering external borrowings more attractive to domestic firms, this may not catalyse enough immediate inflows to stem the speculative run on the rupee. But of even greater concern is the fact that these ideas, if they click, may add to the country’s already high stock of short-term external debt.

Consider the proposal to allow manufacturing firms to tap the External Commercial Borrowings (ECB) route for loans of up to $50 million, for one-year maturities in place of three years. Given that ECBs are still subject to an all-in cost ceiling and end-use stipulated by RBI, this route is accessible only a limited spectrum of borrowers at India Inc. But if such firms do end up raising ECBs for their short-term needs, it can add to India’s stock of short-term external debt, already at 42 per cent of foreign currency dues. By reviewing the mandatory hedging condition for infrastructure loans, the Centre is looking to sweeten ECBs as an option for infrastructure players with prodigious capital needs. But if this measure succeeds, it will render those very same borrowers highly vulnerable to exchange rate risks in future. In fact, the RBI has been taking the opposite road in warning against corporate borrowers leaving their ECB exposures unhedged. Removing the withholding tax on masala bonds and allowing banks to market them are intended to rope in more foreign investors, but it is doubtful if they will take the bait at a time of high rupee volatility. It would be premature to comment on the efficacy of import curbs on ‘non-essential’ items, as the list of such items is yet to be announced. But overall, the move to relax single-exposure limits for FPIs in domestic corporate bonds seems to be the only one of the five measures that may yield immediate results on flows.

The Centre would be better off focussing on measures to address the immediate liquidity mismatch in the forex market. Here, there’s no logical reason to shy away from measures used in the Rajan era, such as the special swap window for oil importers and exchange rate-protected FCNR deposits, which worked very well in 2013. India also needs a hard-nosed analysis of the demand-side dynamics of the CAD problem. With gold imports on a steady decline, the expanding basket of consumer goods imports is crying out for attention. Addressing this may call for structural reforms to kick-start the Make in India initiative.

COMMENT NOW