Abundant global liquidity needs to be tapped
With no short-term solutions to fixing India’s rapidly deteriorating current account deficit (CAD)—gold imports will fall in Q4 since Q3 imports rose in anticipation of a hike in import duty on gold—funding the CAD at 6.7% of GDP in Q3 has become a real challenge. Even an increase in exports in Q4 could see FY13 end up with a 5%-plus CAD. FDI flows, once the traditional financier of CADs, were down to just $15.3 billion in April-December—in Q3, just $2.5 billion of the $32.5 billion CAD was funded through FDI. With the CAD expected to nudge $100 billion, depending on short-term capital flows to fund it is getting increasingly tricky. Short-term debt, of about $90 billion accounts for around a fourth of the country’s total external debt, up from 13.2% in FY05 and 20% in FY10. Moreover, there has been a sharp rise in investment income outflows in Q3FY13—repatriation of loans and deposits—a trend that’s likely to worsen next year.
Over the longer term, there is no option but to get more FDI and finance minister P Chidambaram has said India can absorb $50 billion each year. Since that is clearly a medium-term strategy given the collapse in inflows, India has to tap the abundant global liquidity in the short-term. In the last three months, Indian banks and corporates have mopped up more than $10 billion through dollar bonds at reasonable spreads. SBI is expected to hit the market soon and is looking at picking up $1 billion. Even in the case of rupee bonds where the currency risk is borne by foreign investors, there is scope to attract more foreign funds. Chidambaram made a start last week when he simplified the rules for investing in the local debt market by removing sub-limits across the government and corporate bond categories. While foreign investors have lapped up gilts—the quota is almost full—the response has been less enthusiastic for corporate bonds. Scrapping of the withholding tax—currently at 20%—and the announcement of a roadmap for a staggered increase in the ceiling for both gilts and corporate bonds would convince investors that India is serious about opening up the bond market and attract long-term investors like endowment and pension funds.
Getting quasi-sovereigns like SBI to raise dollar bonds like the India Millennium Deposits and the Resurgent India Bonds raised in the aftermath of the nuclear tests is an obvious option though the costs will be higher. Very large bond issues—$30-40 billion—though could spook investors despite the ample global liquidity. If the government does believe this is an option—since it will bring in 5-10 year money—it would be a good idea to stagger the offering.