Foreign capital could kick-start the country’s investment cycle
It is an irony that in an age of an extreme capital glut, India should be fretting about a lack of capital investment to boost growth. True, our savings and investment rates have plummeted, and we also have a double balance-sheet problem that is yet to be fully corrected. But globally, the one commodity that is being doled out at firesale prices is financial capital.
Two years ago, three Bain and Co. partners and executives wrote an article in the Harvard Business Review suggesting, inter alia, that we were entering an age of “superabundant capital”, with global financial capital estimated at 10 times the global economy. And, it is rising. This capital was not only plentiful, they wrote, but also cheap—available at close to inflation rates. That means real rates close to zero for top companies.
Since that HBR article appeared in early 2017, capital has, if anything, become cheaper everywhere as every country grapples with growth challenges. Globally, according to a Bloomberg report, bonds of nearly $17 trillion yielded negative returns. If you buy these bonds today, you will get less than what you paid for them when they are redeemed. The European Central Bank reduced its rate on bank reserves—money held with it by banks—to minus 0.5%, and will begin buying $22 billion worth of bonds from November in another bout of quantitative easing. In the US, the Federal Reserve may cut rates sooner than later to boost growth as President Donald Trump’s trade wars slow its economy. US 10-year bonds are quoting at barely above 1.5%, and could trend lower if the Fed turns dovish. China has been aggressively cutting rates, and so has India, even though real interest rates at home are still well above the inflation rate.
The signals are obvious for anyone willing to see them. The world is not suffering from any shortage of capital, even if it seems so in India. What the world may be suffering from is risk-aversion. This implies that if India is willing to address those risks, massive sums of capital could flow in. Our real problems will be in handling volatile exchange rates, preventing a collapse in exports, and sterilizing the inflows. We can’t have it both ways. We can’t say we need investment and remain extra cautious about where the money is coming from. To use Deng Xiaoping’s words, it doesn’t matter what the colour of the cat is, as long as it catches mice.
It is in our interest to encourage long-term capital inflows when there is a lot of “patient capital”—capital willing to work on low returns with long payback horizons—waiting in the wings for the right opportunity. Consider the sheer number of European and Japanese pension funds stuck with investments in negative-yielding bonds.
The primary risk that needs addressing is the exchange rate for foreign investors. If we can assure them that these risks can be cheaply hedged, capital will flow in—not just in technology startups and infrastructure, but also into companies marked for resolution or liquidation at the country’s insolvency and bankruptcy courts.
The big question is: What cost are we willing to incur to attract these foreign capital flows? The right precedent to look at is the Raghuram Rajan scheme of 2013, when foreign currency deposits were given forward cover at subsidized rates of 3.5%. We got around $34 billion in deposits, and these sums were unwound without rocking either the forex or domestic rupee markets. Now, with the economy growing larger, our ability to create such a subsidized forward cover regime should be higher—which means we can easily obtain flows of $20-30 billion every year, in addition to the usual foreign direct investment and portfolio flows, for the foreseeable future. This could add up to $100 billion annually, and be hugely beneficial for a general revival in demand.
India is financing bullet train services with a Japanese loan at 0.1% interest. If we can draw 10-year funds in dollars and euros at 2-3% rates, the post-hedging returns needed to make such flows viable for investors would be 5% and upwards. India is likely to have many such infrastructure and industrial projects that could attract these funds.
In the budget, Finance Minister Nirmala Sitharaman had spoken of floating sovereign bonds abroad, but the matter has since died down due to falling domestic interest rates and some negative commentary in the press.
India should cautiously dabble with sovereign bonds to test the market’s appetite and prevent an expansion in the government’s domestic borrowing needs that could push up yields. We must shed our pre-1990s mindset and invite foreign capital in larger quantities to reverse the investment slowdown. Money needs to get active, and there is nothing better than tapping near zero-cost foreign capital for this purpose. Inflows will aid infrastructure builders, who will then boost demand for other goods and services when they spend the money, thus restarting the virtuous cycle of investment, demand growth, higher income, and higher savings.
The key is to overcome exchange rate risk aversion among investors. In the age of “superabundant” capital, one wonders why our economy should operate with a shortage mentality. The answer to our weak capital expenditure cycle lies abroad in the medium term.
is editorial director, ‘Swarajya’ magazine