Firms pay for faulty policy

BS OPINION

The tightening of the norms for external commercial borrowing is the government's latest attempt to limit the torrent of dollars pouring into the Reserve Bank of India's vaults.

The finance ministry has decreed a plethora of restrictions for ECBs "" end-use restrictions for loans above $ 50 million, lowering of the interest rate cap on such borrowings, the compulsory parking of proceeds abroad, and the mandatory hedging of uncovered loan exposures.

The result of all these restrictions will be to seriously curb the ability of companies to borrow abroad.

The interest rate cap of Libor plus 150 basis points will ensure that only the highest-rated companies will be able to tap overseas loan markets.

Are these restrictions justified? It can be argued that the new curbs carry forward the policy measures aimed at curbing arbitrage flows, such as lowering the interest rate cap on non-resident deposits.

Anecdotal evidence does suggest that many companies were borrowing, not so much because they needed the funds but to substitute higher cost domestic borrowing with low-cost (not always hedged) foreign loans.

It is also true that the flood of dollars has resulted in upward pressure on the rupee, and exporters have been complaining.

And finally, the Reserve Bank has been shouting from the rooftops about the need for companies to hedge their dollar exposures.

Nevertheless, there is a fundamental difference between reducing interest rates on NRE deposits and making it difficult for companies to borrow abroad, because the latter measure impacts the competitiveness of companies.

If Indian companies are to hold their own in global markets, they need to access money at globally competitive interest rates.

To be sure, leaving foreign loans unhedged exposes borrowers to foreign exchange risk. But companies are the best judge of their risks, all that the RBI has to do is watch for systemic exposure.

Moreover, it is far from certain that the measures will achieve the government's objectives. The bulk of the addition to forex reserves during the March to June quarter was contributed by FII inflows and NRI deposits, not by external commercial borrowings.

Since then, FII inflows have continued to surge, and the upward pressure on the rupee will continue so long as these inflows remain strong.

Similarly, the biggest uncovered risk in the forex market lies in importers not covering, rather than in unhedged ECBs.

Nor has the quantum of ECBs become so large as to cause concern "" ECBs constituted around 21.4 per cent of India's external debt at the end of June 2003, compared to 22.7 per cent at the end of June 2002.

As for the argument that companies are not borrowing locally because of the easy availability of ECBs, the contrary argument could be that it is only if the blue chips borrow abroad that banks will be forced to start lending at competitive rates to the bulk of Indian companies.

The government's, and the RBI's problem is that they are simultaneously trying to keep the rupee down while propping up interest rates, whereas the logical solution would be to reduce import duties to increase dollar demand. The corporate sector is being made to pay for the government's misguided policies.