Sovereign bonds are tricky, as in an IMF credit line
Given the collapse of the steel cycle, the chances of the South Korean Posco ever setting up its $5.3 billion plant in Karnataka always looked poor, but given the slow progress (till now) on its Orissa plant, it was a fallback option. That option has been firmly ruled out with Posco making a regulatory filing saying it was pulling out of Karnataka. At a time when India desperately needs foreign exchange, the problem is that apart from FIIs who continue to exit—between April 1 and July 15, FIIs have pulled out $2.9 billion—FDI flows need to jump dramatically if the rupee is to remain stable. And that simply isn’t happening. Apart from Posco’s Orissa plant that continues to remain stuck, there is Vedanta’s Niyamgiri project and a host more who have been waiting for years to get clearances. The maths of the impact of this on the rupee is quite simple. Despite the dramatic fall in Q4FY13 current account deficit, the CAD for the full year was $87.9 billion. Even if you assume a lower CAD for FY14 , the question is how this is to be financed. Retaining net FDI remains at even FY13 levels of about $20 billion will itself be a tall task. Assume ECB and other loans are at last year’s level of $31 billion—again, a tall task given few firms are borrowing right now—another $17 billion of banking capital and about $5-10 billion of outflows of hot money. This still leaves the country with another $20 billion or so that needs funding. Traditionally, this would have come in from FIIs, but there’s no certainty of that right now.
Filling that hole is what an NRI bond or a sovereign bond is supposed to do. The problem with a sovereign bond is that, since it needs to be rated, there is always the possibility the rating could be below investment grade. Another suggestion, in this context, is to approach the IMF under its precautionary liquidity line or the flexible credit line—after the global financial crisis, the IMF has become more accommodative in its funding and such lines of credit have less conditionalities attached to them. The problem with both the sovereign bond and the IMF lines of credit, however, is that were either to be exercised, they involve the government making good on various reforms commitments which can be difficult. Even something as simple as selling 10% of Coal India’s shares and 5% of Neyveli Lignite was put off under union pressure. Until the government does something concrete to instil confidence in the overall reforms direction, it’s difficult to see FIIs or others coming in, especially at a time when US yields are looking better. The Food Security Bill, on the other hand, gives the impression the government isn’t fully committed to reforms.