Portfolio Management: How to Use Forex Reserves for Infrastructure
By Vinay Bharat Ram Times of India | February 3, 2005 http://timesofindia.indiatimes.com/articleshow/1009369.cms Prime minister Manmohan Singh, in his speech at the New York Stock Exchange, alluded to an investment requirement of $150 billion in infrastructure over the next 10 years. Some weeks later, Montek Singh Ahluwalia was quoted in the papers as saying it should be possible to draw $15 billion from our foreign exchange reserves to fund infrastructure development. An investment commission under the chairmanship of Ratan Tata was set up by the prime minister ostensibly to accomplish this vision. These seemingly random events appear to be leading up to an immensely laudable goal, even as the building blocks are yet to be put in place. There are those who question the desirability of withdrawing funds from foreign exchange reserves. Their objections fall into three broad categories. First, such a step will increase the already burgeoning fiscal deficit. Second, if this coincides with a flight of capital from the country it could impact exchange rate stability. Third, such a step would be inflationary, as it would amount to increasing liquidity in the system. The first argument is, of course, true. Further, since most of the fiscal deficit exists in the form of revenue deficit, it is a form of dissaving and potentially inflationary. The capital account deficit, however, is not necessarily inflationary or undesirable as long as it leads to the creation of productive assets. Since infrastructure expenditure from the reserves will go towards the creation of productive assets it should be welcomed. The revenue deficit should be tackled as stipulated under the Financial Responsibility and Budget Management Act. Apart from tightening fiscal discipline in the states, policies for hiving off moribund public sector units should be addressed. The dilution of government equity in performing companies should also be pursued. The second concern about flight of capital needs to be examined in view of the composition of the reserves. These comprise FDI inflows, external commercial borrowings by companies, FII investments in equity and bonds, NRI deposits and foreign exchange loans. Of these, FDI investments are the most stable since they go into immovable assets such as plant and machinery. FII investments - in the range of $8-9 million in a year - are often regarded as volatile. But so long as there are no political upheavals, calamities or wars, these investments are likely to stay. Short-term foreign exchange loans could pose a problem but fortunately they comprise a small percentage of our reserves. NRI deposits depend to a large extent on the difference in the domestic and international interest rates, but sustained economic growth will ensure that much of this money finds its way into equity investment. The prospect of capital flight becomes remote as long as there is a positive differential between the growth rate of India and the western countries. The third objection in regard to inflation is a serious one. If the government wishes to withdraw $15 billion from the reserves, it would have to issue special bonds to the Reserve Bank, thus monetising a part of the deficit which would increase the already high public debt. It would also increase the money supply with inflationary consequences, unless the entire amount is used for imports, or the creation of equity backed by productive assets. In infrastructure projects, as is well known, a good part of the investment would be in rupees, thus crowding out other investments and raising interest rates. A way of cooling inflation other than currency appreciation is to reduce customs duties, which is in line with the broader objective of greater global integration. If this reduction targets capital goods and industrial inputs, it could serve to make industry more competitive. However, none of these concerns addresses the central issue - how does $15 billion connect with the prime minister's dream of investing $150 billion in infrastructure? T he $15 billion should be treated as seed money in the shape of equity for leveraging 10 times this amount in the form of debt and equity. A new special purpose vehicle or a corporate body under the aegis of the investment commission could be created with a clear charter for vetting and funding long-gestation infrastructure projects like ports, roads, power plants, dams and bridges. This body should be able to arrange long-term loans at international rates so that equity participation by domestic and global players becomes attractive. A regulatory mechanism should be created, which ensures a reasonable return on investment in the long run. These moves will require coordination not just between the states and the Centre but the entire chain of stakeholders. Here the Chinese model comes to mind. The Chinese government recently used $45 billion of its foreign exchange reserves to fund a new entity, the Central Huijin Investment Company, which, in turn, funded the Bank of China and the China Construction Bank for infrastructure development. Such a strategy, therefore, is not untested. In any event, the returns from infrastructure development should be significantly better than the returns from US or Euro deposits where our reserves are currently parked. Infrastructure development will raise the quality of life in our cities and villages. It will reduce the costs of industry and improve global market access. Infrastructure will attract further investment with positive implications for employment generation, apart from directly generating jobs. Let's go for it. (The author is chairman, DCM Group.) ------------------------ Yahoo! Groups Sponsor --------------------~--> What would our lives be like without music, dance, and theater? Donate or volunteer in the arts today at Network for Good! http://us.click.yahoo.com/TzSHvD/SOnJAA/79vVAA/NJYolB/TM --------------------------------------------------------------------~-> �������������������������������������������������������� This is ZESTEconomics. Post economics-related articles and event info to [email protected] If you got this mail as a forward, subscribe to ZESTEconomics by sending a blank mail to [EMAIL PROTECTED] OR, if you have a Yahoo! 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