Why Chidu's quasi-sovereign bond issue is a stupid idea

Vinaasha kale vipareeta buddhi, goes a Sanskrit saying. It means, when one's downfall or destruction is at hand, one acts in a deluded state of mind. Those who prefer Latin, could try this: Quem deus vult perdere, dementat prius. Whom the gods would destroy, they first make them mad.

The actions of the UPA cabinet over the last few months confirm the applicability of these statements to it. Which is why there is feverish activity to prove both that poverty has fallen, but that you still require a food security bill for two-thirds of the population. Which is why just one man talking governance in Gujarat makes a whole pack of Congress ministers jump in to attack him.

Final proof comes from yesterday's press conference of P Chidambaram, who completed one year as finance minister. Despite the outward calm and confidence, the pronouncements of the sanest minister in the cabinet have started betraying a sense of panic and delusion.



A case in point is the issue of whether the country should issue a sovereign bond abroad to shore up foreign exchange reserves. In the alternative, given the Reserve Bank of India's (RBI's) opposition to the idea, the finance minister said, we could consider a quasi-sovereign bond issue (or issues) by state entities such as banks or cash-rich public sector companies. "All options are on the table".

It is only a few months since the country abandoned the idea of floating a sovereign wealth fund (to invest abroad). Now it wants to float sovereign fund (to borrow from abroad). Swinging from one extreme to another, how delusionary can the government get?

If Chidambaram really wants to help the rupee find its feet, the sovereign/quasi-sovereign bond issue should be off the table for now. It's a stupid idea. It can only damage us as it sends two wrong signals at the wrong time: one, that the government has been spooked on the external front; and two, that it does indeed have a limit for the rupee's depreciation.

Gone is the old assertion that the government does not have any value of the rupee in mind. It is only concerned about volatility. By musing aloud about sovereign bond issues, et al, Chidambaram has just made the rupee even more volatile - especially after saying that the short-term liquidity curbs announced by the RBI to shore up the rupee will go once the currency stabilises. There is now concern in the markets about that the government will do to mess around with the rupee.

The truth is the government is deliberately reading the message in the rupee's fall wrongly because it threatens to expose the accumulated economic follies of the UPA under Sonia Gandhi just before the election.

What is the rupee really telling us when it hits Rs 60-61 to the dollar regularly? Many things, and four in particular.

First, inflation has eroded the real value of the currency. And so it should be priced lower against the dollar. Consumer inflation is nearly 10 percent, and may rise further.

Second, the country has accumulated too much dollar debt ($400 billion). So it should start deleveraging and cutting exposures to external creditors.

Third, exports are uncompetitive. So the rupee needs to be cheaper to give our exporters an edge.

Fourth, the country is over-consuming compared to its productive capacity. This means primarily the government, whose fiscal deficit this year has reached 48 percent of the annual target in the very first quarter. We have swallowed six months of the planned fiscal deficit for the whole year in three months.

Any school economics textbook will give you answers to these problems: reduce external debt little by little, remove bottlenecks to exports, allow the exchange rate to reduce imports naturally, keep interest rates high to improve the supply of savings in the domestic market and discourage overleveraging, and start cutting flab in government, especially on unproductive subsidies.

The government is doing the exact opposite. It is talking of sovereign/quasi- sovereign bonds and making plans to increase external debt. It is trying to raise the rupee's value by artificially constricting liquidity without formally raising interest rates; its import compression measures may end up reducing exports since it is difficult to separate imports that go into export production from imports that are merely for consumption; it is trying to say that rates must be cut, when the opposite is the need of the hour; and it is planning to spend even more on subsidies (for fuel, fertiliser, and food, and now even exports) in the coming months.

So how is the rupee going to benefit? If a 25 percent reduction in the rupee is not going to help exports, will an additional 1 percent interest subsidy on export credit (from 2 to 3 percent) help?

Granted. There is a short-term financing problem, where the country needs more dollar inflows to cover this year's anticipated current account deficit (CAD) in the range of $80-100 billion.

Granted. In the short term, as long as the external crisis persists, there will have to be some kind of import compression. If this means stamping out gold and luxury goods imports, so be it.

Granted. Exporters need a boost for the same reasons. So incentives for higher exports sound like par for the course.

But are these solutions? Is floating a sovereign bond issue abroad - or getting public sector companies to do so - a solution when foreign exchange reserves are at $251 billion (excluding gold)? Is raising more foreign debt at a time when dollar rates are set to rise even wise? The 10-year US Treasury bond has a yield of 2.65 percent right now. Add hedging costs, and the real borrowing costs will be closer to 9-10 percent for any quasi-sovereign borrower. Why does the government want to borrow at 10 percent abroad when it can get the same money at 8-8.5 percent at home? What is the point in giving foreigners a higher return when you want to deny the same to Indian savers?

And does the idea of using the State Bank or Coal India to raise dollars make sense for them? The SBI does not need dollars at such high cost for its business. It will borrow only if the government bankrolls the cost. That's more subsidies. Coal India or ONGC do not need dollars at such costs when they are sitting on cash piles. Why sacrifice profitable companies at the altar of political expediency? Are taxpayer assets like SBI and Coal India or ONGC expendable in the Congress party's re-election quest?

Quite clearly, Chidambaram is practicing bad economics in the name of good politics. Actually, bad politics is screwing up the good economics he had in mind when he returned to the finance ministry.

Here are four simple things Chidambaram can do to revive sentiment.

One, announce that the food bill will apply only to the 22 percent of Indians below the current poverty line. More people will be covered, if needed, when the fiscal situation improves. They are anyway covered by the current public distribution system.

Two, oil prices - at least diesel - should be raised to break-even levels in one go rather than over several months or years. This will cut the fiscal deficit instantly - at the cost of short-term growth. But the message it will send the markets and investors is very, very positive. Capital inflows will automatically follow. Chidambaram will actually have more money to spend on infrastructure, which will revive growth in 2014-15.

Three, he should announce that all projects stuck for environment reasons will be automatically cleared as long as they involve compensatory afforestation, investment in green technology, etc. After a year, these norms can be made more transparent and even more stringent, but now is not to time to hold up anything for green reasons. The same goes for iron ore exports.

Four, the land bill should focus on adequate rehabilitation and compensation, not fixing the multiple payable over market prices for land purchases. The land bill has the potential to kill of growth for at least the next three years.

Sovereign bonds, quasi-sovereign bonds, food security, export subsidies and import compression are short-term economic or electoral placebos that will make the disease worse. They make sense only if the idea is to win the election, but write off the economy for the next three years.

Updated Date: Dec 20, 2014 21:25 PM

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