A V Rajwade: Using forex reserves

WORLD MONEY

In recent weeks, a number of reports have appeared in the media about the United Progressive Alliance (UPA) government's desire to use $ 10 billion from the foreign exchange reserves for accelerating investment in the infrastructure sector.

A financial daily reported (on September 9) that "this proposal is supported by the Left parties who have been demanding that the massive forex reserves...be used to generate employment in the economy."

But as former Infrastructure Development Finance Company (IDFC) Managing Director Nasser Munjee asked so pertinently in a recent article "what precisely is the nature of the problem we are trying to solve?"

There can be no two opinions as far as pinpointing the problem is concerned. First, investment in all kinds of infrastructure "" roads, railways, airports, power and so on "" needs to go up substantially if we are to be a world competitive economy.

(To quote just one number, freight payments in Indian ports amount to 11 per cent of import value compared to the global average of 5 per cent. Again, China's highway network is seven times larger than India's, and the quality far superior "" numbers from a recent article by N K Singh.)

Equally, there is a need for a programme for massive employment generation if only to forestall the possibility of social unrest. But is a reduction in forex reserves a solution to either problem?

Before discussing the issue, let me give an outline of the proposal that seems to be under consideration:

Special purpose vehicles (SPVs) will be established for undertaking major infrastructure projects in the form of joint ventures between state public and private owners.

The government's equity in the SPVs will be funded by monetisation of government debt. In other words, the Reserve Bank of India (RBI) will be asked to buy the securities so that they are not a drag on the resources of the commercial banking sector. This means a corresponding increase in the fiscal deficit.

Since this would lead to an increase in money supply, which would be inflationary, the SPVs would use the capital to import equipment and technology, by buying dollars from the RBI. In RBI's balance sheet, this would amount to replacing forex by government securities, thus, leaving money supply unchanged.

The whole thing sounds plausible and neat. But then there are far too many loose ends:

Is lack of finance holding up investment in infrastructure? How much higher fiscal deficit are we willing to sustain for public funding of infrastructure projects?

If, say, Rs 50,000 crore is the component of imported technology and equipment, one imagines that the total investment would need to be of the order of, say, Rs 200,000 crore! True, IDFC and the banking system have surplus resources to finance the debt component of investments.

But will it be enough? Prima facie, neither the private nor the public sector has the rupee resources needed to finance the equity component, nor the administrative resources to efficiently invest such massive resources in infrastructure.

This point about the total investment needed to absorb $ 10 billion of foreign currency resources has not received much comment. It is worth emphasising that in infrastructure projects "" roads, ports and so on "" the rupee component is quite high in terms of labour, cement and other inputs and a 1:3 ratio may well be conservative.

Is the real problem somewhere else "" the lack of viable projects and the required regulatory changes? If these are in place, why do we need to start with the objective of using foreign exchange reserves?

Since practically everything can be imported freely, the projects will be able to import whatever technology or equipment they need without any hassles. At the macro level, with domestic savings falling short of domestic investments, a deficit on the current account will result and the reserves will drop. Starting with that objective puts the cart before the horse.

The risk in such an approach is that the objective of somehow using up $ 10 billion may only imply that the import will take place and the projects will remain incomplete. As it is, we have any number of projects in the infrastructure sector lying half complete for want of resources.

In successive Budgets, the finance minister has been allocating resources for the completion of such projects in different states; with what results? Incomplete projects only add to the fiscal burdens and do not create either jobs or help growth.

In short, to quote Munjee again, "We are coming up with solutions to problems we don't understand and then devising intricate mechanisms for their implementation that all but ensure that the intended results are rarely achieved."

The Planning Commission consultative committees: I am finding it difficult to think of words other than paranoia ("chronic psychosis marked by delusions of persecution or of grandeur, strenuously defended by the patient with apparent logic and reason") to describe the Left's vehement opposition to the inclusion of a few experts from the World Bank, Asian Development Bank, McKinsey, Boston Consulting Group and so on in the consultative committees appointed by the Planning Commission in connection with the mid-term review of the Tenth Plan.

First, the consultative machinery has no executive powers. Second, to assume that their inclusion would sway the Commission into doing things not in our interest, questions the abilities of the set-up.

Surely, we should have greater confidence in ourselves? What is wrong with learning from the experience in other countries that global organisations have?

The influence of ideas distasteful to the Left comes from many sources "" books, magazines, media articles, academic journals and so on. The logical extension is that we need to ban the import of ideas.

But where would that leave the Left? Its most powerful representative is the only party in the country with a foreigner in its name "" the M in CPI(M) stands for Karl Marx, testifying to its imported ideology. Incidentally, recently the state-owned China Construction Bank added a foreign director to its board, and Bank of China, also state-owned, is following suit!

Email: avrco@vsnl.com