Foreign borrowing or foreign investment?

June 27, 2012

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The market’s response to the currency measures announced on Monday was a dip in the Sensex. Much was expected after the announcement made over the weekend by the finance minister. What has been actually initiated cannot make much difference either to the rupee or to growth.

The measures permit companies to go in for more external commercial borrowings and FIIs to hold more government securities. C. Rangarajan, chairman of the prime minister’s economic advisory council, expects $15-20 billion additionally to come into the foreign currency kitty.

Our current account has been in deficit for a very long time though it has been less than 3 percent of GDP until last year. But in 2012, the deficit has crossed 4 percent, making dollars scarce and pushing the rupee down. To reverse the trend, more dollars have to come in or the RBI has to draw down reserves. The latter can affect investor confidence and, in extreme cases, spawn a financial crisis. Hence, the search for dollars.

The funding of this deficit offers a choice between external debt and external investment. NRI deposits have provided some support though not very significant. The option is between external commercial borrowing and foreign investment, the latter either via stock market by FIIs or direct investment by foreign companies.

Debt has to be repaid and to do that countries are most often required to borrow more in future. Investment, on the contrary, comes to roost but demands a congenial climate. The choice is not entirely our own.

Our external borrowings are comparatively less than those of most other countries though not of China. At the end of 2011, our external debt was $335 billion, about 21 percent of the GDP. But the short-term component of debt at about 23 percent, if paid out, would wipe off 26 percent of our foreign exchange reserves. Our total debt is high because it exceeds our total reserves.

The major borrower externally is not the government but the private sector. External commercial borrowings are about 30 percent of total external debt. That, to an extent, ensures that the borrowed money will be used productively and the borrowers will be able to generate resources for repayment. But that may not necessarily be in foreign currency.

For conversion, they will have to go to the currency market which will only push the rupee down further. Besides, borrowing has now become more expensive and difficult because the economy is slowing down and the rating agencies are competing to downgrade the country and companies.

It is not borrowing but investment that needs to be encouraged because it resides in the country and does not create claims for repayment. All that is necessary is to re-embark on reforms which would stimulate foreign investment and energise the stock market, which is critical even for domestic investment. With reconfiguration of party politics, this is now possible but may take a little time.

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