As for market intervention to stem depreciation, if the Reserve Bank of India (RBI) has to make a sizeable impact on the market, it has to deploy large amounts. Its reserves are hardly equal to five to six days of market turnover. It has to be in the market continuously to achieve its objective. Then, it will run out of reserves within a few weeks as was the case with Thailand, that led to the East Asian crisis and the exchange rate will be back to square one.
The immediate need is to strengthen the reserves and arrest the depreciation of the rupee through the inflow of capital. There have been talks about floating a sovereign bond in international markets. If the purpose is to augment the reserves, whatever resources the country raises will be added to RBI's kitty. It will be invested in low-yielding treasuries of foreign governments and deposits of international institutions. The net outgo due to the difference between interest paid and investment income will be a drain on the forex resources. There are legal problems in floating bonds in the US limited to non-resident Indians (NRIs). And that is the country where there are a large number of high net-worth NRI professionals looking for good yields. At his post-policy meeting with the press, the RBI governor mentioned his reservations about floating a sovereign bond. The central bank has done a cost-benefit analysis of the matter. There are standard textbook arguments like it will lower the interest rates, establish a benchmark for government borrowing and broaden the investor base. But there are costs also besides the compromise in our financial stability. The time for a sovereign bond issue is when we are much less vulnerable to economic shocks than now. In my view, these considerations also apply to banks and corporations floating bonds where the interest rate will be higher than in the case of government borrowing. Rough calculations show that the total cost is likely to be around 10 per cent after factoring in hedging costs.
Would it not be better to promote the NRI deposit accounts in banks? The banks may be expected to utilise the funds for the benefit of the country. They can issue forex loans to corporations on terms competitive in international markets. After the removal of restrictions on interest rates, the non-resident external rupee deposits have seen a spurt in flows amounting to $15.8 billion during 2012-13, against $8.5 billion in the previous year. Data show that much of the flows into the external rupee account were likely to have been diverted from the other two NRI accounts to take advantage of the higher interest rate. Unlike the rupee depositors, who are mostly semi-skilled migrant blue collar workers sending funds to India for domestic maintenance, foreign currency account holders are high net-worth individuals settled abroad. They comprise professionals in various fields who are looking for good yields against the near zero rates prevailing in the West (around 0.15 per cent for one year). Although the interest is free of income tax in India it is not so in the US. Thus, the after-tax difference in interest income may not be much under the current rates in India. The RBI should revisit the issue and consider removing the remaining restrictions on interest rates on foreign currency deposits. It will give a significant boost to inflows. Banks may be expected to be responsible to fix the rates at a viable level. The cost, including the transaction cost, would be less than that of the bond issue. The fear of arbitrage operations and the subsequent run on forex deposits witnessed during the Gulf Crisis should not be a deterrent. India and the world have changed so much in the meantime. As an added incentive, the RBI can exempt fresh accruals to all non-resident deposits from the statutory liquidity ratio considering the current excess investments in government securities.
One important factor that needs to be kept in mind is the impact on money supply. If the forex were to be surrendered to the RBI there will be a one-time massive injection of money when it comes through the bond route. Then, the question of sterilising the inflows will arise with its attendant costs. In the case of NRI deposits, there will be periodical flows that can be managed even if the central bank buys the forex. The question of a massive bullet repayment of loans raised through bonds with its attendant problem after, say, five years, would not arise in the case of deposits where it will be staggered. Although the remittances of NRIs may continue, there could be a deceleration in its flow in view of the restrictions being imposed on expatriates in some of the Gulf countries. The need for capital inflows to make up the current account deficit may be even more in this year than in the last. While foreign institutional investor flows into equity and debt are reversible, foreign direct investment will take time to fructify.
The author is an economic consultant and former Officer-in-Charge, Department of Economic Analysis and Policy, Reserve Bank of India, and IMF Adviser to National Bank of Kyrgyzstan and Bank of Sierra Leone