The Hindu Business Line : Foreign investments

Home Page - Foreign Direct Investment
Money & Banking - Forex
Markets - Foreign Institutional Investors
Industry & Economy - Economy
Columns - Financial Scan
Foreign investments - value subtracting?

S. Balakrishnan

Forget CAC11, or, for that matter, CAC1 - the two reports on the road map for capital account convertibility. The real issues are different.

Some weeks back, the country's forex reserves crossed $200 billion. There were the usual self-congratulations and back slapping. Lost in the euphoria was the fact that the reserves can hardly be called our own. For, they are exceeded by claims from foreign investments of the direct (FDI) and portfolio (FII) types, NRI deposits, external commercial borrowings (ECBs), foreign aid and other capital account transactions.

We have a pretty big deficit on current account (i.e., exports less imports of goods and services and net invisibles).

Fortunately, this is more than adequately funded by capital flows. In March 2006, our external liabilities were $46 billion more than forex assets. (See the RBI's Report on Foreign Exchange Reserves - January 2007).

This situation is very different from China's, whose foreign assets are more than liabilities.

Their reserves of over $1 trillion contain a major `equity' component. We have forex liquidity, which, without question, is absolutely critical to the growth process, but, in corporate finance terms, China's forex balance sheet is net worth positive while ours is negative. By itself, an equity deficit is no great cause for worry. But what is of concern are the astronomical returns on foreign portfolio investments in stock markets, private equity and (now) property.

These are easily in the region of 30 per cent and above (annualised) and entirely free of tax.

In effect, foreigners are taking a significant share of corporate profits in the booming economy, compounded by the (usual) phenomenon of stock prices running ahead because they also reflect future profits. As the vast majority of (listed and unlisted) Indian companies operate only in the domestic economy with purely rupee cost and revenue streams, dollar investments add no value to either the economy or these businesses but morph their large rupee profits into high double-digit dollar returns through the medium of stock markets.

Can we afford it? After all, the other side of the coin is the measly low single digit earnings on our reserves.

The gap between the cost of servicing foreign investment and yield on our dollar investments is probably of the order of 20-30 per cent and could easily amount to value subtraction of $10-15 billion from the economy.

Neither CAC 11 or 1 seems to have touched on this. Perhaps they did not consider it to be in their remit.

Time for another committee to study the issue?