Curbing ECBs- some new proposals

The hottest topic in policy debate today is curbing capital flows into India. Amazing. Barely five years ago, people were talking about the things we should do to attract capital! One item in capital flows that has ballooned is external commercial borrowings (ECBs), foreign loans obtained by Indian companies. This is worrisome because, given the interest differential between India and the industrial economies, it makes sense for Indian companies to raise loans abroad. The appreciation of the Indian rupee makes this even more attractive.

ECBs can become unmanageable if not curbed. The government announced several measures last August, such as limiting the use of such loans in India to $20 mn, the rest of the borrowing having to be spent abroad. The government also has in place a ceiling on the spread over LIBOR that Indian companies can borrow at- this means companies that do not have high ratings will be automatically restricted from raising ECBs.

There is a sense that these measures are not enough and some new proposals have been mooted: auction of ECB loans among corporates and a sterilisation tax that will be borne by companies.The latter is meant to compensate the government for the cost it incurs on sterilising foreign inflows- the government sells securities at Indian interest rates when it sterilises inflows; the foreign exchange that it buys fetches it foreign interest rates. The difference in rates is the cost to the exchequer.

I contributed to a debate in ET on the subject. I don't believe these measures will be effective enough. The government should have a better capacity to sterilise. For this, it needs to have a bigger war chest of market stabilisation bonds and it also needs to bring down domestic rates. It must also act to make returns to investment in India less attractive through, for instance, introducing long-tax capital gains tax on equities.