Hedge fund guy

Hedge fund guy
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First Published: Fri, Mar 02 2007. 12 23 AM IST
Updated: Fri, Mar 02 2007. 12 23 AM IST
What do you call an offshore investment vehicle that borrows money to invest in equity and other financial instruments? A hedge fund, right?
The finance minister announced on Wednesday that two hedge funds would be set up to use the country’s foreign exchange reserves more “productively”. The government is planning to incorporate two subsidiaries of the India Infrastructure Finance Company (IIFC). They will borrow a few billion dollars from the Reserve Bank of India (RBI) and lend them to local infrastructure projects and Indian companies that need finance for overseas acquisitions.
The idea that the pile of foreign exchange that has accumulated in the balance sheet of RBI should be used to finance infrastructure projects in the country, has been doing the rounds for quite some time. It looks good on paper. However, the plan is a deeply flawed one.
Objection number one: The plan does little to actually address the problem it pretends to address. RBI has an embarrassment of foreign exchange riches because the domestic economy has not been able to absorb the capital that has been coming in. Ideally, domestic companies should have bought these dollars and used them. They haven’t, which is why there has been an excess supply of dollars and pressure on the rupee to appreciate. RBI has tried to keep the rupee down by selling it and buying dollars. The domestic infrastructure companies that borrow from these two hedge funds will also eventually have to bring the money back into India. So, dollars go out and come back in. What’s the point?
Objection number two: Some of the funds will be used to help Indian companies acquire abroad. Again, a good idea on paper. The domestic companies that have been busy doing leveraged buy outs overseas borrow money from international banks at market rates of interest. The only reason they will abandon their bankers and borrow from these two funds is if the latter offer them interest rates that are below their market rate. This can happen if the funds can raise money more cheaply from RBI than the international banks. Then the money can be lent at cheaper rates. It’s an implicit subsidy for a few Indian companies.
Objection number three: While it is not the government that is borrowing directly from RBI, it is indirectly involved as the promoter of the two hedge funds. There is another name for government borrowing from the central bank. It is called deficit finance. The entire scheme is actually a variant of deficit finance, though it is being done off-balance sheet.
Supporters of this scheme would ask: Doesn’t Singapore do something similar? The Singapore government runs a government investment fund and a private equity firm. Both invest on purely commercial terms, and a lot of this is overseas investment. So, some of the dollars with the Monetary Authority of Singapore, the central bank in the city-state, leave the country.
That is the crux of the matter—dollars leaving a country. The more sensible and transparent way to tackle the problem of high foreign exchange reserves is to give Indian companies and private investors more freedom to invest abroad.
They will buy dollars in India and invest them elsewhere, taking pressure off RBI and the rupee. The setting up of two hedge funds is both financially unwarranted and an open invitation to political interference on how the corpus of the funds will be used.
In short, it’s a bad idea.
Should forex reserves be used for commercial projects? Write to views@livemint.com
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First Published: Fri, Mar 02 2007. 12 23 AM IST
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