The Hindu Business Line : `Forex reserves for public investment, a sound idea'

Analysts contend that adequate private investment will not flow to many critical infrastructure areas unless financial and regulatory constraints are addressed. And with the bulk of the country's forex reserves earning abysmal returns, it makes better sense to deploy the surplus in public investments — an idea mooted and defended by Dr Montek Singh Ahluwalia, Deputy Chairman, Planning Commission, who elaborated on this theme to G. Srinivasan.

Dr Montek Singh Ahluwalia, Deputy Chairman, Planning Commission

WITH India's infrastructure investment demand estimated at a whopping $150 billion, the focus has, of late, shifted to drawing down a small portion of the $122-billion-plus reserves for financing public investments.

The Planning Commission Deputy Chairman, Dr Montek Singh Ahluwalia, is credited with floating this proposal a few months ago and, ever since, experts and economists have ranged themselves for and against linking the use of foreign exchange reserves to public investment.

The Finance Ministry and the Reserve Bank of India (RBI), though not openly opposed to this proposal, have maintained a circumspect silence, though the apex bank has voiced qualified reservation in going ahead with the scheme.

Historically, the Plan panel has played a proactive role in public investment and the highest functionary in Yojana Bhawan, normally a political appointee aligned to the ideological aspirations of the ruling dispensation at the Centre, has donned the mantle of aGood Samaritan in promoting public investment for its multiplier effect on job generation, durable asset creation and unleashing of growth impulses in the economy.

When the United Progressive Alliance (UPA) Government headed by Dr Manmohan Singh appointed Dr Ahluwalia as the Deputy Chairman of the Planning Commission, strong signals were transmitted that the country's premier policy-making body, under the dynamic leadership of the pro-reform Dr Manmohan Singh and Dr Ahluwalia, would traverse the reform path with renewed vigour and without forsaking the underlying objectives of the UPA's National Common Minimum Programme (NCMP).

But the resources required to get the country's creaking infrastructure in some reasonable shape would entail enormous public investment, given the private sector's invest in these long-gestation projects.

Policy analysts contend that private investment is unlikely to flow to many of the critical infrastructure areas unless questions of financial viability and the regulatory environment are addressed quickly.

The use of the idle foreign exchange reserves, particularly in the debt and equity markets of developed countries, yields but low returns compared to the marginal cost of raising loans abroad through the external commercial borrowing route by Indian corporates, not to speak of the cost our non-resident Indian (NRI) deposits. Hence, there is no harm in using a smallpart of the mountainous forex reserves for public investment purposes, or so say the votaries of this idea.

But the Finance Ministry, through the RBI, appears to be apprehensive over reserves depletion as the blame for any untoward outcome of the squandering of resources would be laid on the functionary presiding over the North Block.

Be that as it may, opponents of the proposal advance the argument that any drawdown of reserves and its concomitant monetisation would have a ricocheting impact on fiscal deficit at a time when inflation is rearing its head. This ought to be viewed against the re-think on public investment by international lending agencies too.

Even an organisation known for its fiscal fetishism — the International Monetary Fund (IMF) — has in its 2004 Annual Report noted that the Fund is reviewing the accounting framework of public investment and has proposed approaches that safeguard infrastructure financing, allow commercially-run public enterprises to be excluded from fiscal indicators and targets, and clarify the accounting treatment of public-private partnerships.

It is against this backdrop that Dr Montek Singh Ahluwalia's proposal on the use of foreign exchange reserves for public inve8

stment ought to be seen and assessed. Not the one to fear criticism of his ideas, Dr Ahluwalia told Business Line in an interview how his proposal could be feasible and workable, despite all the brouhaha it set off.

As India is enjoying exceptional growth, particularly on the invisible receipts front, with a small current account surplus in the economy, Dr Ahluwalia laid to rest any undue alarms among the so-called monetarists.

He has been able to assuage the fears of those who dread the depletion of precious forex reserves on projects that could turn out to be black holes if proper scheduling, from concept to commissioning, is not done and implemented in letter and spirit.

Here is a take from Dr Montek Singh Ahliwalia on his pet proposal to bring a modicum of improvement to the country's infrastructure:

On whether the proposal to part with a portion of the forex reserves, currently at $120 billion plus, is economically sound:

There is some confusion in media reports because of the references to using reserves, implying that the reserves would be invested in securitisation issued by SPVs (special purpose vehicles).

We have in mind a transparent process. In essence, we are saying that we can increase the fiscal deficit or monetise it and offset the negative effects of such monetisation by allowing reserves to finance additional imports.

The essence of the Planning Commission proposal is that starting with a target fiscal deficit, which the Finance Ministry deems appropriate on macro-economic grounds, the level could be increased by, say, Rs 23,000 crore ($5 billion) per year for the next two or three years for the specific purpose of financing infrastructure investment in critical areas.

An important element of the proposal is that this additional fiscal deficit should be fully monetised by the RBI. If the infrastructure projects being financed are 100 per cent importable, then what would happen in sequence is:

(i) the Government would increase its fiscal deficit by issuing government securities;

(ii) the RBI would monetise this part of the deficit by directly picking up these securities. This aspect of monetisation is important since otherwise there would be a potential crowding-out effect as the government borrowing competes for a fixed pool of domestic savings.

(iii) the rupee resources obtained by the Government would be used to purchase foreign exchange of the same amount. The foreign exchange may be purchased from the market, but as long as the RBI effectively intervenes in the market to release this amount of foreign exchange, the exchange rate would not be affected; and

(iv) finally, the 100 per cent imported infrastructure project would be set up and infrastructure capacity augmented in exchange for a drop in reserves.

The non-disruptive nature of this transaction is axiomatic. First, the additional fiscal deficit does not crowd out private investment since the deficit is fully monetised by the RBI. Second, it does not lead to an increase in the money supply since the initial increase in reserve money consequent on monetisation is fully extinguished by the purchase of foreign exchange from the RBI.

Monetarists should be reassured that this is in no way disruptive as there is little alteration in money supply and hence no threat to inflation. Keynesians should also be reassured that there is no net injection of excess demand in the system since the additional investment demand is exactly offset by an increase in imports.

The critical issue is whether the fact that infrastructure projects are 100 per cent importable alters the argument. The Planning Commission contends that if part of the expenditure is on non-tradable goods, then the additional demand will generate a rise in price of non-tradables.

However, the impact of this increase on the overall price level can be offset by allowing the domestic prices of tradable goods to fall. This could be either through cuts in Customs duties on imports or letting the exchange rate appreciate in nominal terms. Reducing Customs duties should be the preferred alternative in our situation since, in any case, it is the Government's avowed policy to bring down Customs duties and it will improve competitiveness.

The cut in Customs duties would lead to absorption of additional imports, which could be met by reducing foreign exchange reserves. It goes without saying that we cannot "use reserves" effectively unless we are wiling to absorb more imports. From a macroeconomic point of view we are at present running a current account surplus for the third year in a row and should not mind an increase in imports.

On the apprehension over the proposal's adverse effect on fiscal deficit:

It will not crowd out private investment because the increase in the fiscal deficit is being monetised and this will not lead to the usual consequence — inflation — because the inflationary impetus will be neutralised by an increase in imports and associated decline in reserves.

The fact that the increased deficit is linked to creating additional infrastructure capacity, a critical gap in the system, should bolster and boost the economy in the medium term. It should help to spur private investment, including FDI, all of which will promote growth in the medium term.

More Stories on : Forex | Infrastructure

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
A new diplomacy for Destination India

A new wage deal

`Forex reserves for public investment, a sound idea'

Worth emulation

A welcome move

Bank employees' demands