The Hindu : Opinion / Editorials : FOREX RESERVES AND INFRASTRUCTURE

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Tuesday, Nov 23, 2004

Opinion

Opinion - Editorials

FOREX RESERVES AND INFRASTRUCTURE

A SEEMINGLY ATTRACTIVE proposal to boost infrastructure development in the country by utilising a portion of the forex reserves has become controversial. The proposal, mooted by the Planning Commission and endorsed by the Union Finance Minister, has however not found favour with the Reserve Bank of India. Its proponents claim an additional benefit besides the obvious one of providing money for infrastructure projects on relatively soft terms and, where needed, in foreign currencies. Drawing down a portion of the $122 billion-plus reserves is one way of putting the stockpile to productive use. At present the reserves, mostly invested in dollar and other hard currency securities, earn a low rate of interest. Loans for infrastructure projects, even when attractively priced for the borrower, will earn more for the Government besides fulfilling a compelling national need. Even the mechanics of administering such a scheme need not be daunting. Although no decision has been taken as yet, it looks as if the forex reserves will be routed through a new special purpose vehicle (SPV) over which the Government will have at least indirect control. The SPV will dispense the loans to eligible infrastructure projects based on its own appraisals and judgment.

While not dismissing the proposal outright, the RBI and other sceptics advocate caution in pursuing a course of action that is not only unprecedented but involves a re-examination of the beliefs that have guided external sector management in this country. Specifically, while forex reserves are at comfortable levels now is there any assurance they will remain so over a fairly long period? The question is important because infrastructure finance is typically for the long term, and the portion of reserves deployed for this purpose cannot be called back at will. The larger issue is therefore one of stability of reserves. The RBI has estimated that at least 50 per cent of the aggregate reserves are volatile and can shift at very short notice. There are enough lessons to be learnt from the 1998 experience of some East Asian and South East Asian countries and also from the more recent experience of Brazil. All these countries once had healthy levels of reserves that were whittled down in no time. The RBI's consistent view has been that the level of reserves should take into account not only unanticipated current account deficits but also liquidity risks arising from unanticipated capital movements. In the most recent period, the accumulation of India's forex reserves has slowed down significantly. There is also a fear that a long-term commitment in rupees will magnify the exchange risks that are always present in the use of foreign currency resources for funding projects in India. There will be a sharp increase in domestic money supply and that will not be good news for those trying to rein in resurgent inflation. The targets for reducing fiscal deficits that the Government is committed to will not be met.

One needs to ask whether infrastructure funding is in such dire straits that unconventional if not desperate methods of raising resources are called for. Several expert groups have noted that the problem in India is not a shortage of funds but slow progress in framing regulatory rules and setting up independent regulators in most infrastructure areas. Granted that the Government has a pivotal role in catalysing private sector investment and providing funds of its own, it is not prudent to divert forex reserves to infrastructure financing, overruling the several well-founded objections.

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