Will FM be able to live up to his CAD promise?

Finance Minister P Chidambaram today reiterated in the floor of the Parliament that India's current account deficit (CAD) will be fully financed. He also highlighted some measures that will be taken in the next few days to attract more foreign inflows.

He said that the CAD is not going to exceed USD 70 billion a year. The government is going to focus on compression of gold, silver and oil demand in order to keep CAD under control.

Sources in the finance ministry told CNBC-TV18 that the compression of oil demand is not going to be via taxes. So, one can be rest assured that the duties on petroleum products are not going to go up, but there is going to be import compression in all these areas as well as non-essential goods.

Also read: SBI results, trade data say GDP will hit new low in 2013-14 

Non-essential goods you are likely to see hikes in import duties. These notifications as and when they happen will be tabled in parliament.

For financing the CAD, Chidambaram said that they are going to take measures to attract NRI flows and these could include liberalisation of NRE rates as well as quasi sovereign bonds which are going to be area of focus. The finance minister did say that public sector financial institutions and these will include sources tell us India Infrastructure Finance Company Ltd (IIFCL), Power Finance Corporation (PFC), Railway Finance Corporation etc are going to be looking at raising quasi sovereign bond issues.

Sources say IIFCL has committed to about USD 1 billion; PFC is committed to about USD 2 billion; Railway Finance is committed to another USD 1 billion. The government already has USD 4 billion that they have got commitments for and more of these are going to be raised going forward.

The FM also spoke about liberalisation of external commercial borrowing (ECBs). Last week there was a meeting in Mumbai of the high level committee on ECBs where we learn a decision has been taken to hike ECBs. In addition to this oil PSUs will also be allowed to raise higher ECBs. On May 14, a decision was taken whereby the three oil PSUs were allowed USD 1 billion each of working capital to be raised via ECBs. So, you could see that limit going up or they could be allowed to raise more through sovereign bond issues.

In an interview to CNBC-TV18, former finance secretary S Narayan and Aditi Nayar, economist at ICRA spoke about their views on the spate of announcements from the finance minister.

Below is the verbatim transcript of his interview to CNBC-TV18

Q: What have you made of the comments that the Finance Minister has made and how much this could help in terms of both the current account deficit as well as the rupee?

Nayar: Broadly in terms of the quasi sovereign bonds that has been mentioned, I believe the Finance Minister has indicated that some PSUs would be allowed to raise quasi sovereign bonds which would help to pull in further inflows of foreign currency denominated debt. Firstly of course such issues are ultimately going to further add to the stock of the debt and that is already one of the concerns that we have as far as the external sector vulnerability is concerned. To the extent that the proposed debt is going to be long-term in nature at least we won't have a near term refinancing issue that would be there.

However, it still remains to be seen which entities are going to be raising such funds and what are they going to be doing with those funds. Is it capital expenditure that they already have plans for that is going to be funded through such issuances because if so then that is at least something that would also add to the overall investment activity in the economy and so that maybe positive. However, more details need to be seen as to who is going to be raising these bonds and what are they going to be doing with that money.

As far as the gold, silver and oil imports are concerned in terms of the trade data that we have seen today one of the positives to me is that the volume of crude oil imports appears to have fallen in July 2013 as compared to last year. Possibly one of the two major reasons for that is of course we have had a better monsoon this year as compared to last year so the demand for diesel to run pump sets either by domestic consumers or by the agricultural sector is possibly a lot lower this year than what it was last year. So, that is overall one positive factor.

Secondly we have now had several months of increases in diesel prices and that again is something that is possibly helping to contain growth of volumes as far as petroleum products are concerned. So, already some measures seem to be having an impact and of course the beneficial impact of a better monsoon is coming in.

Q: We are hearing some comments on what the finance ministry plans to do in terms of tackling the current account deficit as well as the rupee but the rupee sadly has not reacted to any of these measures that have been taken so far and is still gravitating closer to those all time lows. How do you think the situation will pan out from now on?

Narayan: What the Finance Minister is doing to my mind is a bit dangerous. He is increasing the debt by allowing the states or state corporations to borrow overseas. So, in a way there is no solution of how this debt is going to be repaid.

Second, he is doing a very peculiar thing which in a way I don’t understand that he is trying to curb the current account deficit by reducing supply. He is talking about restrictions in import, restrictions in gold and silver, etc and I have not seen a situation where demand gets reduced because you reduce supply. Just the demand goes underground and you are promoting the same kind of import arbitrage that used to happen before 1991. So, this has become a desperate measure.

I would have been very happy if he had announced measures for improving exports. Let's say huge export incentives or encouraging export oriented industries to bring in technology or capital if it had been much more focused. This reduction of petrol, what is going to happen? You setup a huge number of automobile industries in this country by trying to curb crude oil import, what is going to happen to the fuel sector? Are people going to be able to buy for cars or not, this is a bit of a knee-jerk reaction which I am not confident will play out in the long-run.

Q: Will these in anyway help pull further inflows because it seems like that’s the main objective that the Finance Minister has, to pull in further inflows?

Narayan: Certainly, if you raise bonds externally and offer interest rates or offer bond yields which are much higher than what is available elsewhere and so long as there is an implicit sovereign guarantee behind this debt, certainly money will flow in.

However, if you go back to the India bonds which happened when we were in a crisis and if you look at the kind of interest that we paid out on those bonds, it was three or four times what the world was paying for its own bond. So, in a way it is a very high cost kind of protection against the foreign exchange risk.

Q: Do you think the current account deficit would then be curtailed at 3.7 percent or is this just a stop cap measure?

Narayan: Definitely if debt comes in – there is no colour to the dollar. So, whether it comes in as debt or export surplus it will reduce the current account deficit. However, your reserves are getting so much shorter than the total amount of debt that you are actually walking towards the edge of precipice.