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A new facet to debate on convertibility

The absence of an investment grade rating for India may hamper an early decision

A NEW dimension to the debate on full convertibility of the rupee has been provided by a recent study of the international rating agency, Standard & Poor's. The major conclusions of its report entitled "Official reserves: Flexibility is more important than size" do not address the specifics of the rupee's convertibility agenda, including the one that has become the most controversial, namely, how soon should the Indian currency be made convertible on capital account as well.

However, even on that point as on a number of related issues, the report is both relevant and highly topical: its insights based on a comparative study of the key parameters of India's external sector along with those of seven other countries are useful in a broader sense too.

The annual credit policy statement is to be presented on Tuesday (April 18). External sector issues have always figured prominently in these statements. This time, they assume greater significance when convertibility of the rupee has been a frequently discussed point.

According to the report, eight countries (or their central banks) — Japan, China, Hong Kong, Taiwan, Korea, Singapore, Russia and India — collectively hold two-thirds of the world's external reserves.

The reserves are mostly in the form of top rated securities of governments and deposits with highly rated banks. All these countries are net public sector external creditors .Yet their ratings vary.

At one end is Singapore whose sovereign rating is the highest while at the other end India does not even have an investment grade rating.

Paradoxical situation

The paradoxical situation of a net creditor nation like India having a far lower sovereign rating than the U.S. which has one of the highest ratings but is dependent on foreign savings (to bridge its deficits) is well known. It is true that there are a number of other factors that influence a country's ratings.

But the fact that India though comfortably placed in reserves — and on a number of other parameters and having one of the most prudent external sector policies — does not yet qualify for an investment grade rating has wide implications.

The immediate connection to the full convertibility debate is this: the quality of ratings determines the cost of borrowings by a country and its corporates; sub-investment grade means Indian entities cannot raise resources cheaply.

Indian corporate bonds will have to be priced higher to attract investors, reflecting the higher risk profile. These have counted even in an era of limited convertibility, although for a long time it was fashionable to treat the periodic rating exercises of the international agencies with some kind of disdain.

Rating counts

Needless to add, the quality of India's ratings will matter considerably more when capital account convertibility is introduced. One of the big advantages claimed for full convertibility is that it will give Indian entities greater access to global capital.

Foreigners too will enjoy practically unrestricted access to Indian assets. In this scenario, an unequal rating profile may have the negative consequence of domestic savings going after the better rated foreign assets. In that situation, even best-rated Indian companies will have to compete with foreign entities.

Will the Government's borrowing programme, now dependent largely on investments by domestic banks, be a major casualty?

Banks may have to reckon with global investors as much as domestic ones and it is far fetched to suggest that even the strongest, biggest, well rated Indian banks are on an equal footing with the world's leading institutions in the matter of resources mobilisation.

In India the quantum improvement in reserves — from barely $1 billion in the early 1990s to almost $150 billion now — has been cited as one of the principal points in favour of early introduction of a full convertibility regime.

No one doubts or discounts the enormous benefits and confidence that the higher reserves have conferred.

More recently, however, there has been a realisation that the accumulating reserves are not an unmixed blessing as they bring in certain additional costs to the whole economy.

The point is that it is not possible to buttress the case for full convertibility on the basis of a single or a few parameters, ignoring the larger perspective.

The rating agencies suggest that plenty more needs to be done before the country's rating improves to investment grade. Fortunately, there is plenty of awareness already in India that full convertibility cannot be ushered in unless some key signposts are reached.

Those cover macro economic adjustments and financial sector reforms, precisely areas that the reconstituted Tarapore committee, asked to prepare a road map for the convertibility regime, will be looking at.

C. R. L. NARASIMHAN

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