Pressure on interest rates

The Union government's initiative to relax the external commercial borrowing (ECB) guidelines, less than two months after they were made more stringent, may be curious from a macroeconomic point of view.

But this is in line with the series of feel-good liberalisation measures announced by the government throughout this month. Like the earlier initiatives, this one too is bound to be welcomed by the corporates.

The move to put ECBs of up to $ 500 million on the automatic route as also the relaxation in the interest rate ceiling should open the floodgates of opportunity for medium as well as small companies which do not have the comfort of triple-A ratings.

What is also noteworthy is that the stringent end-use restrictions have been removed, allowing Indian companies to raise cheap money abroad for general restructuring purposes too.

Corporate India will welcome this change, because most companies had a genuine desire to raise fresh resources abroad to retire high cost domestic debt, contracted earlier.

This is a fairly genuine requirement for funds, and as corporate financial performance in the last few quarters shows, a reduction in interest costs has been the major driver in the turnaround of fortunes for most companies.

Overall, corporates have much to cheer about in the revised guidelines, though there may be some costs associated with it at the end of the day.

It is a fact that nothing has changed in the economic fundamentals in the last couple of months to warrant a change.

If the logic of the November 2003 tightening was to stem the inflow of dollars into the system, and also restrict the smaller companies' access to the global markets, there is no reason to believe that these concerns have been laid to rest.

The steady influx of FII money is exerting a continuous upward pressure on the rupee. This will only increase with the current relaxation putting more pressure on the Indian currency. Needless to add here that an appreciating rupee will hit all corporates.

The central bank's valiant attempts at sterilising the foreign inflows are adding to domestic liquidity.

But due to the inherent infirmities in the interest rate transmission mechanism, this surfeit of liquidity is not translating into lower interest rates across the board.

By shifting domestic demand for funds from local banks to the overseas markets, the policy will, however, exert pressure on domestic banks to cut their rates further to pre-empt the arbitrage opportunity and to push credit offtake.

If the central idea in the current policy change is to give a fillip to the manufacturing sector, then a simpler and more sustainable course of action would have been to cut domestic interest rates further.

Between interest rates and exchange rates, something has to give way, and given the RBI's current stand on interest rates, it may well be the domestic rupee that will have to bear the brunt of adjustment for some time to come.