| Held in reserve
Ever since the deputy chairman of the Planning Commission floated the balloon of what the media called 'using foreign exchange reserves for infrastructure investment', different views have been expressed on the feasibility and soundness of the idea.
The suggestion was of course not as simple as the media put it. That would have treated foreign exchange reserves as government money to be used as it pleases. That is not so. Most of the reserves are due to non-resident Indians depositing their savings in India, foreign institutional investment in the stock market, funds raised by Indian companies overseas or paid by foreign companies for purchase of Indian assets. Only a portion is due to a surplus in the balance of trade, the surplus of exports over imports that might be regarded as funds that the government can use freely. Foreign direct investment would be another such source. Such funds, unlike much of our foreign exchange reserves, cannot be withdrawn at whim and in some cases can be repaid in rupees.
The Reserve Bank of India holds reserves as investments in other currencies, made up of the dollar (now less than before), the euro (rising holdings), yen and other currencies. They are mostly held in the securities issued by the Central banks controlling those currencies, on which there is a small return. The RBI has to be watchful that the value of these investments does not erode with the decline in value of those currencies. For example, if the dollar declines in value and the original investor whose money makes up the reserves has to be paid in euros, the RBI will have to spend more dollars than it received in the first place to make the repayment. The RBI has to anticipate these fluctuations and move the reserves between currencies.
Obviously the RBI would prefer that the reserves were made up of funds that would not have to be suddenly returned. The FIIs are more likely to move away at short notice. This is because they are invested in the stock markets. Investors might remit funds overseas as they book profits by selling shares. They could also be made nervous about the safety and security of the investment for one reason or the other.
It is this anxiety about the volatility of FII inflows in reserves that the governor of the RBI speculated in a speech whether some way could be found to control this volatile inflow. He wondered if taxing them was a possibility. He also went on to say that experience suggests that taxing them has not been effective when it has been tried in other countries. The response was a volley of rude comment in the media mostly by beneficiaries of the stock-market boom resulting from these FII inflows.
To use foreign exchange reserves for infrastructure financing, the government, through the RBI, could lend to investors at an interest rate that is at least as much as it would have earned by investing in foreign government securities (a way to invest in foreign currencies). These, in any case, give low returns. RBI funding for infrastructure must be at rates that are more than what has to be paid as interest to the NRIs and other depositors whose money it is.
Of course, such funding will release money to buy goods and services. If they are substantial and are spent on goods and services in India, their prices could rise and cause inflation. The lending will certainly raise the government deficit because it is a liability that has been released into the market. The answer would be for government to give it for spending to the maximum extent overseas on goods and equipment for infrastructure. It can encourage this by allowing such imports to be free of duty or at much lower than the ruling rates. There will be a portion spent within India on land, labour and so on, but it may not be large enough to affect prices. The suggestion to use reserves is therefore workable and adds resources even though it does add to the government's deficit.
The real issue is whether there are investors willing to invest in infrastructure. The sectors that require it are roads, power, water, railways, airports and oil and gas. Among these there are models that have worked for private investment in airports, oil and gas. Private investment (and also foreign) has come in in these sectors because the investors feel secure; they see good markets and the opportunity to earn a good return on investment.
Until recently, this was not the case with power. The Electricity Act 2003 was expected to transform the situation, but the calls for reviewing the act and the first two intrusive drafts of the national electricity policy raised doubts about the seriousness of government in attracting private investment. The national electricity policy now approved by the cabinet has laid these doubts to rest. It does not reverse any of the major innovations in the act relating to captive generation, by-passing the state electricity board's veto on purchase and sale of power by third parties in the state, open access, eliminating cross-subsidies, stimulating trading, promoting competition, parallel transmission and distribution, and so on. The promise of the Electricity Act of an enabling environment that would make investment in power attractive can now be fulfilled.
Airports are also on the way to attracting substantial private investment. Soon the airports and civil aviation as a whole must have an independent regulator to set airport tariffs, allocate landing slots, license domestic and overseas routes, and so on. That seems quite likely, thus giving reassurance to private investors that there will be transparency in decisions and an opportunity for all to be heard.
In the case of water, many exercises have been under way to decide how private investment can be attracted. They have floundered on the unwillingness to raise tariffs and particularly for the many poor and urban slum-dwellers. But the growing urban water shortages will compel solutions to be found.
It is in transport by road and rail that there is little progress in creating an environment that will attract private investment. Toll roads are unlikely to be an important method since most roads being built or renovated will be primary roads and not alternatives to existing roads. The low-income poor users have no choice but to use the existing ones, but they may not be able to pay tolls. Most of the new roads may have to be toll-free, but private investment is necessary for speedy road network expansion. For that, innovative ways to assure a reasonable return must be found. The model of having toll-free roads with rights to develop and sell land alongside the road so that the developer can earn his return on investment was developed in Bangalore for the highway to Mysore, but land-hungry politicians appear to have stopped it. Such modes must be pursued.
Railways have considerable scope for private investment, but the railway bureaucracy, led by the inept politicians who become railway ministers and use the ministry for political and monetary gain for themselves, have stonewalled all proposals.
Conditions today are ripe in some infrastructure sectors like power for attracting private investment. Using foreign exchange reserves to enable easier access to funds is a workable route. It leverages available funds but, given the long life of infrastructure assets, its long-term sustainability is in question. Infrastructure funding must match the term of the debt with the very long useful life of the asset. The Infrastructure Development Finance Corporation was set up to do this, but has been unsuccessful.
There are issues to be resolved, primarily those that involve protection of the poor and vulnerable sections. Introducing competition to provide choice and lower tariffs, ensuring adequate returns, developing and monitoring trading and markets, a clear and speedy legal framework, and a strong and transparent role for capital markets are necessary. For these the ideal governance is through independent regulation. But while this institution has been established for some sectors, it has so far been a sanctuary for retired government servants. The government must make them vibrant, with younger and better-trained independent professionals.