Abheek Barua*
Last night, Finance ministry announced a slew of measures aimed at containing India’s current account deficit (CAD), in light of surging global oil prices and a deprecating rupee.
- The measures are primarily aimed at easing conditions related to external commercial borrowings, hedging conditions for infrastructure loans, and loosing restrictions on masala bonds.
- The government believes that these five measures could to lead to additional capital flows to the tune of USD 5 – 10 billion and limit the currency pressures to some degree. We are doubtful about the impact of such measures in the immediate future.
Five measures announced yesterday:
1. Mandatory hedging conditions for infrastructure loans will be reviewed. As of now, such borrowings must be fully hedged, which makes it expensive for companies to raise funds overseas. Thus, easing of the mandatory requirements in this domain could make it cheaper for infrastructure companies to raise funds as well as refinance costlier debt.
2. To permit manufacturing sector entities to avail external commercial borrowings up to $50 million with a minimum maturity of one year versus the earlier period of three years. This could ease two important constraints in this regard. For one, this could make dollar borrowing attractive for short-term capital needs. Two, hedging cost for such borrowings could come down. This is because hedging products beyond one year are not that liquid and are costlier.
3. Removal of exposure limits of 20% of FPI’s corporate bond portfolio to a single corporate group, company and related entities, and 50% of any issue of corporate bonds will be reviewed. Earlier this year, the RBI already eased some of the restrictions in this regard. For example, the central bank allowed FPIs to invest in corporate bonds with minimum residual maturity of above one year (the requirement was three years earlier). However, it had kept exposure limits unchanged – which could be eased now.
4. Exemption from withholding tax for issuance of Masala Bond issues done in FY19. Industry estimates in this regard show that withholding tax (of around 5%) generally adds 40-50 bps to the cost, and at times takes the overall cost of borrowing (through Masala bonds) higher than what an issuer might have received in the domestic rupee market.
5. Removal of restrictions on Indian banks’ market making in Masala Bonds, including restrictions on underwriting of such bonds.
Apart from these capital account focused measures, there was also a promise to curb non-essential imports to compress the trade deficit. However the specific items would be determined only after consultation with different ministries and ensuring that the measures would be WTO compliant.
What kind of impact can we expect?
In our view, the capital account measures announced yesterday are unlikely to result in any significant shift in fund flows in the immediate future.
These measures are better suited when the sentiment in the global market is positive towards emerging markets and in general when it is relatively easy for emerging market corporates to raise money abroad. For example, the demand for masala bonds from offshore investors is generally driven by the stability of the rupee. In an environment, when the rupee is under pressure, foreign investor would not me much willing to increase its portfolio of rupee denominated assets (unlikely to bet further on the rupee).
Similarly, a lot would depend on how quickly and easily the Indian corporates are able to garner additional short- term debt through ECBs or portfolio investments. We believe that giving additional exposure limits to FIIs might not be much helpful when they are already pulling out money from the Indian markets.
Looking at a broader level, some of the emerging markets are considered vulnerable today because of the rising current account deficit problems and on account of worsening short-term external debt situations. Against such a backdrop, considering that most of the measures (announced yesterday) aim at increasing short-term external debt or in effect worsen the risk profile of companies (by increasing un-hedged exposure), could actually be considered negative. Increase in short-term ECBs or FII exposure could lead to further worsening of vulnerability ratios and the global investors might actually take this negatively.
In terms of impacting on market sentiment, the decision to curb imports might have some effect since it strikes at the heart of the current problem. This could mean that the INR trajectory might not see a full reversal of the appreciation move of the last couple of days. That said, markets will wait for clarity on the specific items that face these curbs before give a thumbs up to the rupee. While this could be a small near-term fix, protectionist gestures are viewed with some caution by global investors as it gives the impression of a reversal of ‘reforms’. We see this as potential negative for the currency beyond the very near term.
Prime Minister Modi is likely to hold another review meet today
It is important to note that yesterday’s meeting was one under a series of meetings that Prime Minister Modi is likely to hold with various stakeholders to review the current situation of the economy. There could be additional measures announced today. Hopes are high around Prime Minister’s economic review meeting that is likely to happen today (at 4:30 pm). As per the media reports, Finance minister Arun Jaitley, Reserve Bank governor Urjit Patel, and some senior government officials are likely to attend the meeting. Apart from a general economic update, the expectation is that the policymakers will explore additional intervention measures to tame the slide in the rupee and options to curtail any further rise in oil prices. We await this before taking a final view on next week’s trajectory of the INR.
*Mr. Abheek Barua, Chief Economist, HDFC Bank. Mr. Barua tweets at @AbheekHDFCBank.
