Tough steps to check foreign inflows likely

The Reserve Bank of India and the finance ministry are working on a concept paper which will look at the feasibility of levying a sterilisation tax and auctioning the limited foreign loans quota to help moderate the inflow of funds through external commercial borrowings (ECBs). Foreign borrowings are currently over $25 billion a year.

The finance minister had earlier hinted at some control measures if capital inflows became excessive and unmanageable. On the foreign borrowings front, the RBI had sought comments from the finance ministry on a suggestion to have a sterilisation tax on all ECBs.

RBI, which has bought over $61 billion from the open market since January, has had to sterilise a lot of liquidity (local currency) released into the system. It loses about 3% on such sterilisation effort — the difference between what it earns on deploying reserves mainly in the US treasury and the interest it pays in the domestic market for sucking out liquidity by issuing government securities. The idea is possibly to pass on some of the sterilisation cost to the ECB borrower.

This would also increase the cost of borrowing and thereby minimise the interest rate arbitrage which prompts Indian corporates to borrow cheap abroad. Higher interest rates in the country have forced Indian companies to borrow less here — thereby impacting credit offtake of local banks — and look for cheap funds overseas.

Another idea being explored is the auction of ECBs, something the Russians have been doing quite successfully. Since many corporates are vying for a limited ECB quota, the more needy may be willing to pay extra in an auction to access foreign borrowings. Sources said these measures are seen as purely temporary, aimed at managing capital flows.

The central bank is understood to be working on a concept paper on these measures which could be explored as an option in future, if capital inflows go out of hand. A decision on this would be taken only after the paper is finalised, which will have inputs from the finance ministry. Since this would be first-of-its-kind measure in the country, even the operational procedure has to be discussed threadbare besides the concept, they said.

The government has already taken various measures since April to moderate ECB flows. In April, it was announced that all foreign investment coming in as non-convertible, optionally convertible or partially convertible preference shares would be considered as debt.