Desperado

Less than a month into his new job as India’s finance minister, P Chidambaram is in a hurry to rev up the economy’s sputtering engines. But with inflation still high – the rate just dipped below seven per cent for the first time in 32 months — the central bank in Mumbai is reluctant to help by cutting policy interest rates. So Chidambaram wants to rely on the magnanimity of the US Federal Reserve, the European Central Bank and the Bank of England. He is nudging local companies to take more loans denominated in foreign currencies.

Such borrowing used to be tightly restricted, but the government has been loosening the rules. Mortgage-finance companies recently got the government’s blessing to finance low-cost housing with cheaper overseas funds. Manufacturers and those constructing roads or power plants can now replace more of their rupee debts with foreign-currency borrowings.

The short-term savings are substantial. Thanks to near-zero policy interest rates in much of the developed world, highly rated Indian companies are able to borrow overseas funds three to five percentage points below the cost of rupee loans.

And, in the short term, the practice isn’t too dangerous. Official foreign-currency reserves are large enough to repay almost the entire $335 billion external debt, about a fifth of the country’s annual output.

Over time, however, a fall in the rupee or a rise in foreign interest rates can turn such loans into a millstone for the borrowers. If recent trends continue, the whole country could get into trouble. While the crisis of 1991, when the Reserve Bank of India basically ran out of hard currency, is far away, the stock of foreign debt has shot up by 32 per cent in the last two years even as foreign-currency reserves have fallen.

Chidambaram is chasing poor-quality GDP growth. That’s pointless. A more sustainable course would start by slashing wasteful subsidies, speeding up infrastructure projects and implementing a much-delayed goods-and-services tax. None of those steps are easy, but a government that doesn’t even try will further undermine investor confidence – making foreign-currency borrowing even riskier.