The new restrictions on external commercial borrowings demonstrate several things. The concerns for plugging inflows into unproductive channels through end use restrictions and preventing impairment of corporate balance sheets by making hedging mandatory are steps in the right direction. The same, however, cannot be said of measures to prevent all but the very best of corporates from accessing cheaper capital abroad. The severity of the measures curbing commercial borrowings abroad is the toughest signal yet of the worries afflicting the authorities, namely, the enormous cash lying unutilised with the domestic banks and the autonomous inflow of foreign capital, which has to be contained somehow. In trying to reconcile the two, ECBs are being used as a tool for short-term management of the capital account, in effect blocking capital inflow via this route by fiat and forcing domestic borrowers to borrow from domestic banks who are unable to reduce their lending costs. This desperation not only signals that capital mobility has now entered a phase where the authorities are searching for temporary tools for short-term management of capital flows, but also that in the search for such tools, the burden of policy uncertainty is going to be shouldered by residents rather than the non-residents. In deciding who will extract the gains of capital account liberalisation and in what order, it is evident that the foreign institutional investor rather than the domestic borrower will get precedence; in the uneven dispersion of these benefits, it is the relatively smaller borrower that will be rationed out.
Why not raise the costs for the foreign investor to dissuade excess inflows After all, the latter have a shorter time-frame than commercial borrowings abroad, which have maturity restrictions anyway, undertaken explicitly for financing investment plans and difficult to misuse. The experiences of Chile, Israel and Malaysia also prove that temporary restrictions on hot inflows dont necessarily thwart good flows, for instance, foreign direct investments. The only argument in favour of this move is that debt is costlier than equity and for the country as a whole, external debt has to be monitored and kept within prudent limits. But the current external debt profile is hardly worrisome at this juncture to warrant this consideration and it must be the apprehension of sovereign credibility that has tilted the choice in favour of the FIIs. One must then conclude that the appeal of killing two birds with one stone has led to this policy move. The sooner this is replaced with smarter policy moves to correct the distortion of excess liquidity with banks and unwilling borrowers as well as managing the inflows, the better it would be.