Last week the finance ministry allowed Indian companies to access yuan-denominated loans from Chinese banks within certain limits. This decision has deeper economic and strategic implications for India. Overall, the decision to allow companies to access yuan loans flows from the larger agreement among the BRIC nations in Sanya, a resort town in Southern China, earlier this year when it was decided that that these economies would start lending to each other in local currencies and conduct a part of their trade in domestic currency. This was seen as a small but significant step towards deepening cooperation among BRIC economies which are progressively increasing their share of the world output. In purchasing power parity terms, emerging economies are well over 50% of the global output. The decision to start trading in each others? currency also partly flows from a concern that the dollar and euro may experience far greater volatility as the western economies decline over the medium to long term.
India?s decision to allow corporates to borrow yuan-denominated loans is guided by many factors. One, of course, there is a big demand for yuan loans from companies who are importing equipment and machinery from China for infrastructure development. The managing director & CEO of IDFC, Rajiv B Lall, told FE that many infrastructure companies would want to borrow in yuan if given good terms.
The finance ministry?s timing was guided by another important factor. At present, a lot of foreign loans to Indian companies come from the European banks. Given that the Eurozone is in deep crises, some of these loans from European banks could dry up. This had happened when the financial contagion had spread to Europe after the Wall Street meltdown in 2008. In fact, net debt inflows from the West had collapsed by over 80% in 2008-09.
By opening the yuan loan window, the government is only ensuring that the lend-able pool of foreign loans to Indian corporates does not shrink. This is a short-term imperative to ensure adequate credit supply to businesses in India.
The new yuan window has many possibilities. RBI will soon come up with further guidelines and conditions under which companies could borrow from the Chinese banks, which are evidently very keen to lend.
For instance, for loans from international financial institutions, the current norm is companies have to borrow within an interest rate ceiling of 500 basis points above LIBOR (for 5-year plus maturity). Typically, infrastructure loans are necessarily of longer maturity and not many Indian banks are able to meet this need because of asset-liability mismatch.
RBI will have to come up with a similar benchmark for yuan loans from Chinese banks. Since it may be difficult to find the equivalent of LIBOR in China, RBI may simply put an overall interest rate ceiling. Typically, a large size company with AAA rating accesses foreign loans (5-year plus) at an overall rate of 10%, which also covers hedging risks. This is about 150 basis points cheaper than a domestic rupee loan.
RBI could insist on a similar interest rate (with exchange risk covered) for Indian corporates wanting to borrow from the Chinese banks. Since China is very keen on progressively internationalising its currency, the People?s Bank of China (central bank) may nudge their commercial banks to lend to Indian companies at very attractive rates, which also cover the exchange risk.
At present, the yuan is on a partial float and the extent of appreciation of the yuan is pretty much decided by the Chinese government from time to time. The Chinese central bank could, therefore, also informally give an exchange risk assurance to Indian borrowers. For instance, an Indian company borrowing from a Chinese bank could get a reasonable assurance that over the 5-7 year tenure of the loan the yuan would appreciate no more than 10% against the dollar. In short, there could be some certainty about the exchange rate movement. This is possible in a managed float, whatever market purists may say about it.
In any case, the exchange rate markets have baffled purists with their irrational behaviour in recent years. How else do you explain the Japanese yen strengthening even as its economy is in unmistakable long-term stagnation. The dollar also strengthens as the US economy shows clear signs of long-term stagnation. All such contradictions are explained away by market experts with a simple and convenient terminology, i.e., flight to safety! Humans have a natural fear of the unknown. A known path, as represented by the euro or the dollar, gives comfort and a feeling of flight to safety, even if it is leading up to some cul-de-sac. All financial market players are part of this herd which wants the comfort of the well trodden path. After all, they are only human!
However, a time also comes when the bottom-up market dynamics throws an alternative, like the dollar decisively replaced the pound after the First World War when the British economy was tottering on the brink of bankruptcy. By then America had clearly emerged as a net financier of the UK and the rest of Europe. And mind you, that shift had happened in the age of mercantilism when free cross-border trade was still a distant dream. Is it any surprise that accusations and counter-accusations of mercantilism are resurfacing today?
mk.venu@expressindia.com