Subsidised Forward Cover For Asset Sales May Bring In Massive Dollar Investment Flows

Prime Minister Narendra Modi wants India to become a $5 trillion economy by 2024. Maybe a dollar target sounds sexier, but he should have really set the goal in rupee terms, where it is easier to break down the headline gross domestic product (GDP) number and see which sectors will produce the kind of value-addition needed to achieve that goal.

But one thing is clear: this goal cannot be achieved without private investment perking up significantly, and this must be the area of focus for the government. Given a falling savings rate, and the weak investment ability of the corporate sector due to deleveraging and excess capacity, the logical assumption must be that the gap must be filled by foreign savings and investment.

India’s gross savings rate has fallen from 34.65 per cent of GDP in 2011-12 to less than 30 per cent five years later, according to Reserve Bank of India (RBI) data. It will be even lower now. This drop has been led by the drop in household savings, which tumbled from 23.6 per cent in 2011-12 to 17.2 per cent in 2017-18.

In an interview to The Economic Times this week, the Prime Minister tried to talk up investor confidence by emphatically stating that he wants them to make more money. Profit is not a dirty word for him. “We want entrepreneurs to get better productivity and better profits, we want our industries to grow in speed and scale, we want our businesses to get access to bigger markets, both at home and abroad. We want our investors to earn more, invest more and create more jobs.”

More importantly, he gave investment pride of place in his plans to boost growth. “The vision for the next five years is to have investment-led growth. We are targeting Rs 100 lakh crore worth of investment in the coming five years. To achieve this vision, the government is working on policies to promote inflows from domestic as well as foreign sources. This would entail further liberalising our FDI policy, simplification of labour laws, further enhancing ease of doing business, power sector reforms, asset monetisation and asset recycling in public sector, and reforms in banking, insurance and pension sectors. While investment has to be driven by private sector, the government will do its bit to crowd in (investment).”

Given the government’s limited fiscal space this year, the crowding-in of private investment will have to take place by other means. It implies that asset sales have to precede a hike in government spending on infrastructure, which is what will crowd in private investment by putting money in the hands of businessmen and consumers.

NITI Aayog has a plan that involves privatising many existing assets of the public sector beyond just land. It wants to sell assets like electricity transmission lines, telecom towers, gas pipelines, and some more airports, too. And then, of course, there are the thousands of kilometres of already built National Highways that can be sold to bidders for 20-year tolling franchises. The idea is to raise more than Rs 3 lakh crore.

The problem with these plans is that the domestic private sector simply does not have the bandwidth to buy them off government’s hands. The only people with the ready cash to buy them at one go are foreign pension and insurance funds apart from other long-term investors.

Given the low returns on safe long-term assets like US treasury stock (the 10-year bond had yields of 1.65 per cent on Tuesday), or even negative yields on German and Japanese bonds (-0.63 per cent and -0.22 per cent respectively), investors would gladly invest in long-term Indian real assets with significantly higher yields.

The only problem is the exchange rate risk: the cost of forward cover is more than 7 per cent, and this is what makes Indian asset purchases unviable for many foreign investors. The answer, therefore, should be to offer investors in physical assets a subsidised forward cover at, say, 3-3.5 per cent, for blocks of three years, and then extend them at higher rates, or even at the same rates. Extension should depend on what costs were actually incurred in the initial subsidies offered. If the exchange rates hold steady, the costs can sometimes be even zero or negligible.

This, in fact, is what former RBI governor Raghuram Rajan did in 2013, and raised more than $34 billion in non-resident Indian dollar assets. The cover was unwound without causing major market mayhem three years later.

Is there any reason why similar amounts cannot be raised by selling road or pipeline assets to investors who can be given an exchange rate guarantee at a price?

Sure, there are risks, but if we could take those risks in 2013, surely 2019 can’t be any worse than that time, when taper tantrums were about rising rates? Today’s currency volatility is about rates going lower in a global downturn.

The sale of such assets to foreigners will boost dollar inflows, which means the rupee may grow stronger, and need sterilisation to avoid inflation. Strong inflows over five years may even strengthen the rupee to a point where the forward cover subsidy may actually involve very low cost to the exchequer. Once the pump is primed, future foreign investments may come in even without the subsidy in sectors with higher return potential.

It is an idea worth examining this year, for we have to break the vicious cycle of low savings, low investment, and low growth by changing the equation at the start: by tapping the capital surpluses and savings of the developed economies.