A year ago, the government and the Reserve Bank of India (RBI) doubled the limit that foreign institutional investors (FIIs) could invest in government paper, to $10 billion. Now, if news reports are to be believed, it is proposed to double the limit again, to $20 billion. In itself, this is not a large enough sum to cause worry, but the context is important — at a time when the large interest rate differential between India and much of the world presents a temptation to overseas lenders. FIIs have put a total of Rs 90,000 crore (about $18 billion) into Indian debt paper in the last five years, with the bulk of that money coming in during 2010 and 2011. On top of this, external commercial borrowings by Indian companies have ballooned, and now top $100 billion — with about 20 per cent of it not even hedged to protect against currency movements. Similar stupidity had landed quite a few companies in trouble after they issued foreign currency convertible bonds (FCCBs) some years ago. When the overseas buyers chose not to convert the bonds into equity because domestic share prices were unattractive, some companies could not buy back the bonds as they were obliged to, as they did not have the reserves with which to do it.
There are three points of worry today. The overall foreign commercial debt exposure has become large, when juxtaposed against the size of the country’s foreign exchange reserves (about $300 billion). This is particularly so when the current account deficit (the difference between what India exports and imports) has been running at about three per cent of GDP (roughly $50 billion). FII money in the equity component has seen a net outflow this calendar year, a repeat of 2008, though the outflows are much smaller this time. If the country’s forex reserves have held up nevertheless, it is only on account of debt inflows in various forms (including from non-resident Indians). Finally, the government’s borrowing programme has crossed all previous limits, and certainly gone beyond budgeted levels; this is driving up interest rates. Also, a recent issue of government paper devolved on RBI. The government and RBI are, therefore, looking for the easy way out of the macro-economic imbalances and domestic debt market problems by borrowing abroad — hence the move to double the FII limit for exposure to government paper.
But the history of the last couple of decades is replete with cases of countries and companies that thought borrowing overseas was a soft option, and which then landed in trouble when international currency markets sprang a surprise. Could India be exposing itself to similar risk? Admittedly, Indian external borrowing policy has been relatively cautious, but what is one to make of a decision to allow five-year infrastructure bonds to be floated internationally, with a put option of 18 months? Which infrastructure project can earn the cash flow to buy back debt in 18 months? A safety valve is provided by the country’s flexible currency policy (or the rupee would not have dipped 10 per cent in a few weeks), but that itself could be a risk factor for companies with unhedged overseas exposure. In any case, the appetite for risk seems to have grown precisely at a time when world markets are less predictable than before. Different crises are sweeping through the developed countries and the world economy is still characterised by fundamental macro-economic imbalances that the G20 has not been able to deal with despite a declared intention to do so.
