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Modi govt announces five-point plan to control current account deficit

Arup Roychoudhury, Anup Roy & Subhayan Chakraborty/New Delhi/Mumbai 15 Sep 18 | 01:29 AM

(From left to right) Prime Minister Narendra Modi, Finance Minister Arun Jaitley and RBI Governor Urjit Patel

A high-level meeting chaired by Prime Minister Narendra Modi on Friday decided to curb non-essential imports and increase exports, besides announcing five-pronged measures to increase dollar inflows into the country to fund and reduce the current account deficit (CAD).

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The CAD rose to 2.4 per cent of the country's gross domestic product (GDP) in the first quarter of 2018-19 from 1.9 per cent in the fourth quarter of 2017-18. 

These measures will increase dollar inflows by up to $10 billion in the country. 

The government decided to cut non-essential imports and increase exports, Finance Minister Arun Jaitley told reporters after the meeting, adding the measures would be announced in the next few days after consultations with the ministries concerned. 

However, experts are not impressed. “This is an old narrative, from before the liberalisation era when non-essential imports were, to an extent, considered to be anything apart from petroleum," said trade expert Biswajit Dhar said.

However, in today's global trade regime, one has to be careful in imposing tariffs, he added. 

Other experts suggested gold and electronic equipment, which make up some of the single-largest chunks of the import bill, might be targeted.

The trade deficit, which is the biggest part of the CAD, reduced to $17.4 billion, lower than the $18.2 billion in July. So, in July and August the trade deficit has risen to $35.6 billion after it stood at almost $45 billion in the first quarter of the current financial year. As such, the CAD will come under pressure now, with economists forecasting it at 3 per cent of GDP in the current fiscal year.

For a few dollars more

Mandatory ECB hedging conditions for infrastructure loans will be reviewed

IMPACT: Due to hedging costs of 4-4.5%, the cost of borrowing for even well-rated companies crossed 9% (LIBOR at 3% + spread of 2-2.50% + 4- 4.50% hedge cost). Now, companies will be able to raise dollar loans more comfortably.

To permit manufacturing companies to avail of ECBs up to $50 million with a minimum maturity period of one year

IMPACT: Will reduce hedging cost; the three-year maturity period increased borrowing cost,  leading to loss on interest 

Companies can raise shorter period money and roll it over. The cheaper funds can also be used to retire high-cost ECBs. 

Removing 20% exposure limit of FPI’s corporate bond portfolio to a single corporate group, and 50% of any issue of corporate bonds will be reviewed 

IMPACT: Yield-chasing FPIs will show renewed interest in investing through NCDs, especially in real estate companies. This will also encourage new lower-rated issuers to come into the market to raise dollars through NCDs. 

Exception to masala bonds from withholding tax for issuances up to March 31, 2019

IMPACT: Removing withholding tax of 5% on interest rates means investors in overseas markets can invest without worrying about tax cut. The issuer can also offer better returns or issue at a lower cost. 

Removing restriction on Indian banks’ market-making in masala bonds, including underwriting of masala bonds

IMPACT: Indian companies can now go to local branches of Indian banks to manage masala bond issuances. Earlier, they had to use infrastructure of foreign stock exchanges and contact foreign underwriters. Not many companies had that reach or comfort. 

The measures, taken after the presentation by RBI Governor Urjit Patel and Economic Affairs Secretary Subhash Chandra Garg, included easing investments by foreign portfolio investors in corporate bonds, reviewing mandatory hedging conditions for external commercial borrowings (ECBs), allowing the manufacturing sector to go for ECBs, and making it easier to go for masala bonds, Jaitley said. 

The measures are aimed at increasing capital flows into the country to finance the widening CAD. Garg said the measures would increase dollar inflows to the tune of $8-10 billion into the country.

The government decided to review the mandatory hedging conditions for infrastructure loans, permit manufacturing entities to avail of ECBs of up to $50 million with a minimum maturity of one year against three years now, remove the exposure limit of 20 per cent of FPIs’ corporate bond portfolio to a single corporate group, companies and related entities, and review 50 per cent of any issue of corporate bonds, abolishing the withholding tax for issuing masala bonds during 2018-19 and removing restrictions on Indian banks, market making in masala bonds, including restrictions on underwriting of masala bonds.

Experts said the steps would bring in dollars, but not immediately.

“The most important point is that investors should have clarity about the stability of the rupee so that they can draw actionable investment strategies around it," said Indranil Pan, chief economist at IDFC Bank. 

What it would do, however, is that it will give comfort to the markets that the RBI and the government will be there to act in case the rupee slides out of hand. Importantly, Jaitley has not announced any dollar bond, or dollar deposit schemes, and also refused to discuss them.

Bank of America Merrill Lynch’s treasury head Jayesh Mehta said they steps would not only bring in dollars but help a lot of companies with financing needs.

“With the RBI’s prompt corrective action (PCA) framework, many banks are not able to fund the infrastructure sector or manufacturing companies. In an environment of bankruptcy proceedings, these companies are also struggling to raise funds. Allowing them to raise funds directly from abroad at cheaper rates helps these companies to a great extent," said Mehta.

Mehta said many companies were reluctant to go abroad to raise funds because of the hedging costs. Hedging would add 4-4.5 per cent of the cost, which drives the cost of the loan to 9.5-10 per cent even for a better-rated firm. The review of this would immensely help companies raise cheap funds. However, the finance minister said the RBI would review it. So some amount of restrictions could still be expected, otherwise the country’s external debt profile runs the risk of ballooning.

Also, by allowing manufacturing companies to tap ECB loans of a year's maturity, the government not only allowed them to save hedging costs, but also retire high-cost ECBs raised earlier with cheaper ECB loans.

Jaitley’s third point, of allowing FPIs unlimited access to any NCD issuance, or removing the investment cap on any company, can be a bit problematic as this will lead to hot money in certain sectors. 

Masala bonds are a great initiative, said Mehta. By withdrawing the withholding taxes, Jaitley widened the investor base manifold. 

A senior currency dealer said: “The measures were not really big, but they spell out the government’s intention clearly and is a big caution for speculators. Frankly, Wednesday’s 70-paisa rupee movement shows some banks acting as speculators had driven the rupee down." 

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