Govt readies for surge in dollar inflows

Budget raises provision for market stabilisation bonds.

The finance ministry is preparing for huge dollar inflows next year as well, going by the provision for market stabilisation bonds (MSS) in 2008-09.

The MSS issuances budgeted for 2008-09 are Rs 2,55,806 crore, significantly higher than the estimate of Rs 1,41,135 crore in the 2007-08 Budget, and marginally lower than the actual issuance of Rs 2,71,903 crore in the financial year on account of equity investments by foreign institutional investors (FIIs) and overseas borrowings by companies.

Finance Minister P Chidambaram told Business Standard in an interview on Saturday that he does not know “which way the cat will jump” (meaning, whether there will be dollar inflows or outflows), so he is merely providing for the eventuality of inflows.

“If the interest rate differential remains large, more capital could flow into India. If there are payment obligations back home, capital could flow out of India. So we are just making sure that we are prepared to meet either eventuality,” the finance minister said.

Subir Gokarn, Chief Economist, Standard and Poor’s (Asia Pacific), said the higher MSS provision for 2008-09 reflects the government’s readiness to deal with an elevated level of capital inflows.

It also shows that the government is ready to check a sharper appreciation of the rupee, he added.

The rupee has appreciated around 14 per cent against the dollar in the past year. The finance ministry has, however, maintained that the appreciation has been around 6 per cent on a real effective exchange rate basis in 2007.

The MSS issuances are currently capped at Rs 2,50,000 crore, with Rs 2,35,000 crore set as the threshold for a review of the ceiling. The ceiling was raised four times in 2007-08 from less than Rs 1,00,000 crore at the beginning of the year. Total MSS bonds outstanding on February 22, 2008 stood at Rs 1,76,018 crore.

Money received through the MSS bonds issues is placed in an escrow account. The balances in this account are used only to redeem the bonds on maturity. The interest cost is borne by the government.

At the beginning of 2007-08, the budgetary allocation for interest payments on the MSS bonds was Rs 3,700 crore. The allocation was raised to Rs 8,351 crore. For 2008-09, the finance minister has made a provision of Rs 13,958 crore for such interest payments.

Rupa Nitsure-Rege, chief economist at Bank of Baroda, said: “At some point, overseas investors will have to look at China, India and other high-growth Asian economies for investments as developed economies face slowdown”.

Capital inflows have created difficulties in monetary management for the Reserve Bank of India which has struggled to defend the rupee and contain inflation.

Higher foreign exchange inflows have to be absorbed by the central bank to check the rupee from strengthening and this has to be followed by measures to absorb the resultant rupee liquidity to contain inflation.

In August 2007, the Reserve Bank of India (RBI) had restricted the end-use of overseas borrowings. This apart, fresh overseas borrowings above $20 million were restricted only for foreign currency expenditure.

In the first six months of the current financial year, gross external commercial borrowings (ECBs) rose, year-on-year, by 81.1 per cent to reach $14 billion.

Total portfolio flows into India — including proceeds of depository receipt issues and investments by FIIs — during April-December 2007 amounted to $32.8 billion against $7 billion in the whole of 2006-07.