The buildup of foreign exchange reserves, now over $140 bn, represents a major transformation for a country long used to facing a foreign exchange crisis with every external shock. There has been a lot of debate recently on mobilising these reserves for the country’s dev-elopment. A proposal by Dr Montek Singh Ahluwalia, deputy chairman of the Planning Comm-ission, to create a special purpose vehicle to use these for infrastructure development has been discussed extensively.

This debate, however, seems to have overlooked another potential channel for gainfully mobilising these. This is to feed the growing demand of Indian corporates for foreign exchange resources to fund expansion. Indian firms have been raising forex resources abroad under external commercial borrowings (ECB), which could be in the form of syndicated loans and issues of bonds in developed-country markets, such as European and North American countries. In addition, Indian companies raise foreign ex-change resources through issues of ADRs and GDRs, including Foreign Currency Convertible Bonds (FCCB).

Recent trends show the demand from Indian enterprises for these resources has been growing quickly. Financial institutions and major companies are planning to raise over $2 bn in the first quarter of FY 2005-06 itself. The list of potential Indian enterprises seeking to raise ECBs with a bond issue includes financial institutions such as the State Bank of India, ICICI Bank, Hudco and Bank of India, each seeking to raise $300 million. And companies such as Hindalco ($300-500 mn) and Essar Steel ($300 mn). Idea Cellular is seeking to raise $100 mn through an issue of bonds, besides a syndicated loan. Therefore, in a full financial year, Indian companies might be raising upto $8 bn in ECBs.

In addition, Indian companies are reported to have raised $3 bn through FCCBs over the past year, besides issues of ADRs and GDRs. The servicing burden on ECBs typically includes a spread on top of ruling Libor (London Inter-Bank Offer Rate) rates for the relevant currency. The size of spread depends on many factors: credit ratings of the country, the borrower, maturity terms, etc. Borrowers also take the currency risk. Generally, these ECBs are covered by sovereign guarantees from the Indian government. With the improved credit ratings and liquidity position, the spreads applicable to Indian issues have declined, making these more attractive for borrowers. Further, the rupee’s appreciation in the recent past has also reduced the currency risk, thus making these borrowings more attractive.

On the other hand, our growing forex reserves need to be parked somewhere. Most governments typically invest these in American treasury bonds, beside other securities issued by developed country governments. These securities yield very low returns so the net yield after transaction costs and currency depreciation might be negligible, if at all positive. This is forcing major Asian countries, which together hold US$2 trillion worth of forex reserves, to look for alternatives for diversification of their investment baskets.

Discussions are on for mobilising these resources for the region’s development. These in-clude a proposal for a Reserve Bank of Asia, besides an earlier Japanese proposal for an Asian Monetary Fund. RIS research has shown that even a modest mobilisation of Asian reserves in such an institution could, to begin with, provide a reasonable basis for exchange rate stability in Asia, while promoting development of regional public goods in Asia.

These plans may take a while. Meanwhile, it might be worth exploring the idea of mobilising these through foreign currency bonds issued by domestic companies. This would require development of a local market for foreign currency-denominated bonds, providing an avenue for investment of these reserves within the country.

With the development of an Indian market for foreign currency-denominated bonds, Indian companies will be able to raise their requirement of ECBs locally, by issuing bonds to the Reserve Bank of India, or a special purpose vehicle acting on its behalf to invest a part of forex reserves in the bonds of local companies. With the growing requirement of such borrowings by Indian companies, this could become a viable option.

The benefits of such a proposal would be many. First, it will help raise yield on forex reserves. Second, it will lower the heavy and growing servicing burden on account of ECBs. Since the servicing burden of such borrowings will be payable within the country, the forex outgo will be reduced to that extent. Some may argue that such mobilisation of forex reserves will not be prudent, as the bonds issued by local companies might not be as safe as US treasury bonds. However, the consideration of risk is a non-issue, to the extent that the borrowings of Indian companies are generally covered by the sovereign guarantees issued by the Indian government. Further, if necessary, a system of reduction of risk can be evolved as in the case of normal lending programmes. In any case, the mobilisation of reserves in the local market for forex-denominated bonds could be limited to a small specified proportion of such reserves.

Thus, the development of a local market for foreign currency-denominated bonds represents a good option to diversify the investment basket for the reserves, increasing the return on their investment, while reducing the forex servicing burden of foreign borrowings by companies.