At a time when fast tracking infrastructure projects has emerged as a crucial policy action for rejuvenating investment demand in the economy, a flurry of activity is currently underway to pull all stops which come in the way of getting stalled projects off the ground. The ubiquitous Cabinet Committee on Investment has been tasked with removing the glitches in inter-ministerial coordination which is expected to help unfinished projects to take off. But would clearances help projects off the ground or would infrastructure financing emerge as the next bottleneck? And would the recent depreciation of the rupee aggravate the problem of investment and project financing?
Indeed, the precipitous fall in the value of the rupee since the last two months has baffled policy makers and industry alike and affected project planning. Indeed, the rupee has fallen by almost 13 per cent against the dollar since the beginning of this year. What is more, it has touched an all time low of 61.19 in July. Besides, the unprecedented volatility in the value of the rupee is creating uncertainty among investors who would like to wait and watch the situation or even exit from projects now considered to be unviable.
The downward slide of the rupee is most likely to affect infrastructure projects dependent on international funding. Big companies which have raised capital through external commercial borrowings would now be required to pay higher interest. Project cost is anticipated to go up and those with thin margins would be most affected. A fall in the value of the rupee would hit their bottomlines in a big way and many would be forced to rework their economics to stay afloat
Similarly, importers of project equipment would also find their costs rising. Many domestic equipment suppliers which have tie ups with international companies could also revise their prices upwards to meet the erosion in the value of currency. This is especially the case with projects in the power sector which have been relying heavily on imported equipment to meet their requirements. Most such companies have already been affected by delays in award of project. The power companies are also impacted by the rise in price of imported coal due to the weakening of the rupee as they are unable to entirely pass through the fuel costs. Similarly, repairs and maintenance of aircrafts are also impacted by downward swing of the rupee.
No doubt, private infrastructure projects in India are largely funded by banks which comprise around 21 per cent of total funding. Another 14 per cent is funded by NBFCs and insurance companies while foreign investment comprises 14 percent of project finance. To that extent, the impact of rupee depreciation would be neutral on their borrowing costs. The impact on importers of equipment who had hedged their currency against the dollar would also be minimal. However, domestic financing of infrastructure projects is inadequate, uncertain and often ridden with constraints. While demand by project developers remains strong, the financiers are selective about project funding. The procedural complexity of accessing timely credit adds to the problems. The lack of depth in the financial markets and inadequacy of alternative sources of finance leaves developers with limited options.
In such a scenario, firms resort to external commercial borrowings which promise timely credit at cost effective rates. Presently, ECBs account for 6 per cent of total external finance. However, if the revenue stream is in rupees and companies have taken a currency risk in their cost estimates, then there is a problem as the payback would be more than what has been factored in.
In such a scenario, what are the options before policy makers? In the immediate term, the RBI should take steps to augment the supply of foreign currency to stem the volatility in the rupee. The government is indeed mulling over the option of issuing sovereign bonds for NRIs on the lines of Resurgent India bond and India Millennium Bonds to reduce volatility and strengthen the rupee. This needs to be given proper shape. Similarly, a special window for supply of dollars at reference rates would also rationalize the demand for dollars.
In the medium term, however, the government should push through long pending initiatives in the financial markets so that infrastructure and power companies could hedge their risks and are in a position to cope with currency risks in the international financial markets. The deepening of capital markets and encouraging the development of corporate bond market including the introduction of municipal bonds as in the USA would go a long way to bring foreign into the country. mitigate the problem of finance for the infrastructure sector. Similarly, insurance companies could be allowed to invest in long term bonds/securities to evolve an optimal debt structure to minimize cost of debt servicing.
Presently, the economy is witnessing a sharp rise in the number of stalled projects led by those in the electricity and construction sectors due to land acquisition and environment considerations. It should not happen that once the policy bottlenecks are cleared, factors such as the depreciation of the rupee lead to a spike in project costs and emerge as yet another reason for shelving the project.
Furthermore, opening up the coal sector to competition would help build domestic capacity and check imports of power utilities which have gone up substantially due to the weak rupee. This is making a dent in the bottom lines of power companies by raising fuel costs and reducing margins. No doubt, the government is contemplating to widen the scope of public private partnership in this sector involving Coal India ltd. While this would mark a beginning of bringing limited competition into this sector, the decision is still a long way off from fully opening up the sector to private industry.
Finally, a fresh burst of long pending reforms which would fire up the economy and bring growth back to the pre-crisis level. Growth is the best antidote to fight rupee depreciation. We need to move fast on addressing currency risks and improving our access to the financial market. It is pivotal for the government to implement measures for increasing the supply of dollars. This will help to take off some depreciation pressure from the Rupee. The tapering of the QE by US Federal Reserve by the end of the current year will happen in all probability in view of the better-than-expected economic data coming out of the US. In order to make the country’s financial system resilient and not too dependent on short-term capital flows, it is imperative that government announces measures to raise the sectoral FDI caps in most sectors. Speedy return to high growth on a sustained basis will be a critical pull factor. If this happens rupee can regain its long-term appreciation bias and the economy would regain its momentum of growth.