IMD Suddenly Looks Wise

The India Millennium Deposit (IMD) scheme, which collected $ 5.2 billion from non-resident Indians in October, was widely castigated as expensive and unwarranted foreign borrowing.

But today fears of a global recession are spreading fast. That makes IMD look like a wise precaution. If indeed a global recession strikes, IMD will look like an act of awesome economic foresight.

Yashwant Sinha will probably get job offers from Wall Street.

In the last few months, the US stock market has plunged, and fears of recession are rampant. The US has been running a trade deficit of a mammoth $ 450 billion, and this has helped other countries to keep exporting more. A US recession will halve its trade deficit, shrinking the global export market by over $ 200 billion in one go. The US is India\’s biggest export market, so we could be hit even worse than in the 1997-99 Asian financial crisis. Savage price cutting by competing countries will depress export prices, as in 1997-99.

Foreign direct investment in India will be discouraged by global over-capacity. Foreign portfolio investment may shrink dramatically. A recession increases global perceptions of risk, and Third World investments have always been regarded as the riskiest. Global investors will flee to the safety of US treasury bonds. So, expect to see a big sell-off by FIIs in India, draining our forex reserves and hitting our stock markets. The software export boom will slow down in a global recession, affecting the one segment of the stock market that has sparkled in recent years.

Now, all this may prove to be a false alarm. As the saying goes, journalists have predicted 20 of the last five recessions. Optimists hope that the US is simply slowing down from an unsustainable growth rate of 5 per cent in 2000 to a sustainable 3 per cent or so. If so, the US economy will achieve a soft landing, and everybody will be happy. However, soft landings are difficult to achieve, and countries typically plunge into recession before recovering. So, while hoping for the best, we must prepare for the worst.

The IMD now looks like a wise preparation for the worst. It is vital in a crisis to maintain foreign confidence in India. Foreign portfolio investors hold more than $ 11 billion of investments in India, and NRIs depositors twice as much as that. Labour remittances total $ 12 billion a year. If there is a sudden loss of confidence in India, all these sources of forex could dry up, and the ensuing panic could drain our reserves.

IMD has strengthened our forex position by $ 5.2 billion. That has improved global confidence in India\’s ability to weather a global recession, and represents a huge potential benefit.

IMD pays an effective 8.7 per cent interest, much higher than the 7.9 per cent paid in the earlier India Resurgent Bonds scheme in 1998. Some Indian borrowers like IOC borrowed dollars at around 7.5 per cent earlier in 2000.

So, IMD was initially criticised for paying exorbitant interest. Moreover, the interest on NRI dollar deposits in India is only around 6.5 per cent. Critics feared that NRIs who would normally have invested in fixed deposits at 6.5 per cent would switch to IMDs at 8.7 per cent, an expensive diversion. IMD dollars have been borrowed not by the government but by the State Bank of India, and the government has guaranteed it against foreign exchangefluctuations. So, if the rupee depreciates over the next five years, that will raise the rupee cost of repaying the deposits after five years, and the burden will fall on the government. Much IMD money will ultimately be lent by the SBI to the government, and thus finance not productive investment but fiscal imprudence.

Most of these criticisms begin to lose their force in the face of a global recession. Yields on all Third World debt have risen in recent months. The floating rate notes of Power Finance Corporation, a public sector undertaking, now yield close to 9 per cent. The yield on the biggest emerging market debt fund, run by Morgan Stanley, has shot up from 10 per cent to over 12 per cent in the last three months. That reflects the sort of return global investors now expect on Third World debt. India would not be able to raise $ 5.2 billion today save at very high interest rates of 9 to 10 per cent. Argentina is borrowing at 13 per cent. So, IMD is suddenly looking like a financial bargain.

Does it represent a diversion of normal NRI bank deposits? After the 1998 India Resurgent Bonds there was a very modest dip in NRI deposits, suggesting only minor diversion. Remember that most NRI deposits are of one year\’s duration, while IMD locks in money for five years. In 1991, NRI deposits were withdrawn at the rate of $ 80 million per week, hastening bankruptcy. IMD money cannot leak out in this fashion: it is locked in for five years. Even if as half a billion dollars of IMD represents diversion from bank deposits, the additional interest outgo will be only $ 10 million annually, a small price to pay for the security of large reserves.

The final criticism remains valid. IMD will finance the government\’s fiscal deficit through foreign borrowing, a rather unhappy state of affairs. Some hard decisions need to be taken to reduce government overspending.

Privatisation needs to be speeded up too. The fear of recession has already dampened investor sentiment. The longer the government delays sales—whether of Air India, IBP, MTNL or anything else–the lower are the prices it is likely to get. It will be tragic, yet true to form, if the government finally opens shop just as a global recession strikes, and finds there are no buyers.

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