Thursday, August 30, 2007

Is using forex reserves for funding infrastructure too risky?

Yes, argues an ET editorial. Let’s take a look at it.

The government has directed RBI to invest $5 bn of forex reserves in the special purpose vehicle (IIFCL) floated for funding infrastructure needs of the country. The entity would fund equipment buys and investment by Indian companies abroad.

How far such a direction is tenable is questionable. RBI’s mandate of investments is drawn from Section 17 of the RBI Act. It allows investments only in gilt-edged securities with maturities less than 10 years, in bonds issued by other sovereign states and deposits with multilateral institutions. But government has argued that clause 13 of the same Section empowers the Central board to approve investments by RBI in foreign institutions.

Funding infrastructure needs out of our huge forex reserves is bad because, it is not lack of funds which is hindering infrastructure growth; it is lack of bankable projects. In such a scenario, funding the unbankable project through the use of the special purpose vehicle (IIFCL) will only result in the SPV not being able to service its bonds over a period of time and the all too familiar cycle of writing off of the bonds have to be lived with. This is nothing short of deficit financing.

On the other hand, if the projects are designed in a bankable way, then there is no need for them to use the SPV route at all. So this clearly brings out one thing – the accounting fudge being indulged in by the government; nothing more nothing less.

A better solution therefore is to moderate forex reserve growth through greater exchange rate flexibility; hiving of forex reserves management to a professional investment agency like China Investment Trust or Singapore’s Temasek, and simultaneously reduce policy waffle so that infrastructure projects get financed on their own strength.

So argues the ET editorial. But is the move really that bad? I don’t think so. Everybody knows that infrastructure needs of the country are very high. It is also a given that the country is on a growth path and is expected to stay the course in the medium to long term. This makes the prospect of securitizing the loans advanced by the SPV look attractive. Create an international market for such securitized assets; and I am sure it will whet the appetite of the international investors in the India growth story. Secondly, the proposed route is not much different from the method and manner in which the CIT and Temasek are investing for long. So, why should there be any objection? Lastly, is $5 bn such a huge amount when we are looking at $240 bn reserves? Why keep looking at only the downside all the time? Can’t we look at the upside? I think the fears are largely unfounded.