Risks of crony capitalism

Should the government assist Indian banks and companies that have borrowed billions abroad, and suddenly find it difficult to repay maturing loans because the global financial crisis has frozen money markets? Russia and Mexico have thrown lifelines to their debt-laden companies. Korea has guaranteed $ 100 billion of foreign bank loans.

Should India do something similar? Only on a very limited scale, if at all.

Indian companies have borrowed $ 150 billion abroad. This is spread over hundreds of companies, and the big borrowers are financially sound. That cannot be said of all Russian tycoons. If global markets remain frozen, Indian companies will surely ask for government assistance.

Other emerging-market governments have justified corporate rescues as win-win strategies. The RBI keeps forex reserves mainly in US government bonds, yielding around 5%. But Indian companies today pay 10% or more for dollar loans, and often cannot get loans on any terms at all. If India, like Russia, creates a war chest of $ 50 billion for rescues, this sum can be switched from 5% US bonds to 8% dollar bonds issued by Indian companies. That will increase the government’s income, while easing the credit crunch on companies too.

A win-win situation? No, it would be crony capitalism. Indian companies must learn that foreign borrowing carries unanticipated risks of the sort evident today. In good times companies have gaily ignored these risks. It is fair and just that they should suffer the downside of foreign debt, just as they benefited from the upside earlier. We must not privatise profits and socialise losses.

Besides, our forex reserves of $ 270 billion no longer look so large. Foreign institutional investors could pull out another $ 50-80 billion from our stockmarkets, creating a run on the rupee. That will slow or paralyse remittances from overseas Indians, which provided an invaluable $ 42 billion last year. Unlike Russia, we must use our reserves carefully and discourage crony capitalism.

Having laid down this principle, we can accept the case for exceptional action in exceptional circumstances. When markets freeze in a panic, there is a case for government intervention until the markets unfreeze. But it should be limited in duration and volume, and involve penal interest.

Indian banks now have hundreds of branches in many countries. In India, they get money mainly from deposits. But abroad, they borrow from wholesale money markets, and re-lend this to their clients. In normal times, they roll over their borrowings—that is, they borrow afresh to repay old loans. However, the financial crisis has frozen markets and rollovers, stranding Indian banks.

A government committee has reportedly recommended helping bank branches abroad till the panic subsides. It suggests that $ 5 billion from our forex reserves could be invested in dollar bonds of Indian banks, keeping them liquid in the current storm. The interest rate would be higher than the 5% the government earns on its forex reserves.

If Indian banks fail to repay their dollar loans, the government’s own creditworthiness will be affected. The $ 5 billion proposed is modest, covering only a small part of banks’ obligations. So, despite misgivings, I would support this proposal. The rate of interest should be penal, inducing banks to return to global markets quickly and not become addicted to government help.

However, I oppose dollar loans to corporate giants. Tata Motors and Hindalco recently came out with rights issues to raise domestic money to repay huge dollar loans they had taken to acquire Jaguar-Land-Rover and Novellis respectively. The rights issues failed dismally. Other businessmen ask, how can we raise money when even Tata and Birla cannot?.

Russian tycoons have pledged big stakes in top Russian companies to take dollar loans. The Russian government argues that these stakes in key Russian companies will become the property of foreign banks if the tycoons are not enabled to repay their loans. Indian companies might make a similar argument.

The argument must be resisted. Russian tycoons have been reckless. Indian tycoons must not be encouraged to follow suit, with the assurance of rescues if things go wrong. Indian companies must be forced to confront the risks of huge foreign loans. Nor should India’s limited forex reserves be frittered away in repaying irresponsible corporate debts.

Okay, some companies will say, don’t give us any dollars from your forex reserves, but at least give a government guarantee to cover our dollar loans till the panic subsides. Without a guarantee, many of us cannot raise money at any price today. So, even sound companies find it difficult to repay old loans.

Normally, I am dead opposed to government guarantees. But in a global panic, there is a case for guarantees if they thaw an otherwise frozen market. The government must charge a substantial penal fee for giving such guarantees. The guarantees should be valid for a maximum of two years, so that companies return to unguaranteed borrowing quickly. Finally, such guarantees should be limited to large, demonstrably solvent companies. This still carries the risk of crony capitalism. But in a global panic, the risk may be worthwhile.

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