JULY 29, 2015

By TIOL Edit Team

INTERNATIONAL Monetary Fund (IMF) has advised India to observe caution in further liberalizing external commercial borrowings (ECBs) framework. It has also given a subtle reminder to Modi Government to stay focused on economic reforms against the backdrop of fragile global financial environment.

We may here add that political turmoil has somewhat distracted the Government from the growth and reforms agenda. The political turmoil is of the Government's own making. It has to managed well to ensure that legislative agenda especially goods and service tax bill is passed as early as possible.

IMF's advice is timely as Finance Ministry has to take a call on the ECB-liberalization recommendations of Sahoo Committee whose report was released in April this year for seeking public comments.

In its 'The 2015 External Sector Report-Individual Economy Assessments' (ESR-IEAs) released on 27th July, IMF notes: "Given the potential risks to corporate balance sheets, including from significant unhedged FX exposures, further relaxation of limits on ECB (especially for sectors without natural hedges) should be implemented cautiously."

Companies have on average mopped up about USD 30 billion annually in recent years from overseas debt markets. A rating agency report in 2013 noted that half of Indian corporate ECBs are unhedged, which raises risk of default and systemic financial year.

As noted by RBI in its Financial Stability Report released on 25 th June, "possible adverse exchange rate movement arising out of financial market volatility may negatively affect corporates with unhedged foreign exchange exposures and may have implications for financial stability."

Even Sahoo Committee aptly observed: "ECB is not an unmixed blessing. It exposes the borrower firms to currency risk. When the country has managed exchange rate system, firms undertake more ECB exposing them to higher currency risk. This currency risk, if not hedged by a large number of firms, has the potential to trigger systemic risk for the financial system in case of sharp currency fluctuations."

While recommending replacement of discriminatory and discretionary ECB regime with one envisaging level-playing field, it has pitched for hedging. The Committee has proposed linking of ECB liberalization to mandatory hedging of a part of loans by corporates.

As put by the Committee, as "ECB borrowing firms introduce risk to the system, they need to be obliged to hedge the risk either through natural hedge or financial hedge (in currency derivative market)."

The challenge in framing a new ECB policy lies in balancing hedging cost of borrowings with the attractiveness of unhedged loans. Pending formulation of new guidelines, RBI should prod highly leveraged companies to reduce their exposure to currency fluctuation risks to avoid default and sickness.

IMF believes that the global financial environment will be complicated by the diverse risks associated with especially accommodative monetary policies of certain countries.

In another related 'External Sector Report', IMF says: "Emerging markets and those with excess current account deficits may be most vulnerable. Policies there should aim at steady external adjustment but also to strengthen frameworks; policymakers should be prepared to respond flexibly to changing financial conditions using a range of tools."

Coming to non-ECB factors for India, ESR-IEAs says: "To reduce external vulnerabilities and reach the authorities' fiscal deficit goal of 3 percent of GDP by 2017/18, continued fiscal consolidation is needed, including by passage of a goods and services tax, and further subsidy reforms. Easing domestic supply bottlenecks would also boost exports and improve investment prospects."

Modi Government has to actually undertake a multi-facet approach to cushion the economy from fragile external environment. A positive feature of environment is subdued global commodity prices upto March 2016 as projected by the World Bank. The Government must seize this as an opportunity to undertake expenditure reforms.

In the absence of these reforms, the attempts to achieve fiscal consolidation through revenue buoyancy might not be durable. It is likely to yield sub-optimal results.

Time is now ripe to for undertaking politically sensitive and over-due urea subsidy reform. This should be marketed to the farmers as balanced fertilizer usage package for restoration of soil health and for boosting stagnating crop yields.

The Finance Minister Arun Jaitley has kept mum on issue of implementation of recommendations of Expenditure Management Commission (ERC), which submitted its interim report in time for incorporation of its recommendations in the budget for 2015-16.

Even the report(s) of ERC have not been made public. This makes us wonder whether the Government is frittering away not only the rare decisive mandate of 2014 polls but also the opportunity emanating from subdued global commodity markets.

According to the World Bank's latest quarterly Commodity Market Outlook report issued on 22nd July, Fertilizer prices are likely to decline 5 percent on weaker demand and ample supply in 2015.

As put by the report, "All main commodity price indices are expected to decline in 2015, mainly due to abundant supplies and, in the case of industrial commodities, weak demand."

In his maiden regular budget for 2014-15 presented on 10 th July 2014, Mr. Jaitley had stated: "My Government is committed to the principle of "Minimum Government Maximum Governance". To achieve this goal, time has come to review the allocative and operational efficiencies of Government expenditure to achieve maximum output. The Government will constitute an Expenditure Management Commission, which will look into various aspects of expenditure reforms to be undertaken by the Government. The Commission will give its interim report within this financial year. I also propose to overhaul the subsidy regime, including food and petroleum subsidies, and make it more targeted while providing full protection to the marginalized, poor and SC/STs. A new urea policy would also be formulated."

Mr. Jaitley ought to give an update on this forgotten resolve.