Friday, June 22, 2012

Why our PM ‘gave’ US $10 Billion to the IMF

In a live debate telecast on a local TV channel, an economist who is a spokesperson and supporter of the ruling party was outraged that the PM had given away US $10 Billion (equivalent to Rs 56,000 Crores) to IMF’s Eurozone debt bailout fund when he was reluctant to give less than a quarter of that amount to the debt-burdened local government.

Many fellow citizens must have felt the same way – going by the chatter in different online forums. Has our economist PM gone bonkers, or was there a method to his madness? Digging a little deeper, the facts came out quite clearly. Our honourable PM may be indecisive, and lack charisma but he is nobody’s fool.

First of all, the $10 Billion was not ‘given away’ like a gift or aid. It was a pledge to contribute to an emergency fund, which will be used only if needed. There are other countries who have pledged similar or different amounts. For the complete list of the countries who have pledged to contribute to IMF’s Eurozone bailout fund, click here.

The total pledged amount by different countries comes to $456 Billion, which will be used as a second line of defence only if resources already available are used up. By the way, the ‘available resources’ includes an earlier $13 Billion pledge from India.

What if the available resources are used up and India is called upon to pay the $10 Billion? The amount will come out of India’s foreign exchange reserves – which is currently about $290 Billion. That constitutes less than 3.5% of the current reserves.

IMF will return the money with interest – so it will be a ‘loan’ and not a ‘gift’. How will India benefit from such an arrangement? There are two benefits – one political and the other financial.

For quite some time, the emerging economies – particularly the BRIC nations – have been demanding more say in the way IMF is managed and run. IMF has so far been dominated by European developed economies. It will need to accommodate the aspirations of emerging nations, but is extracting a price in terms of more financial contributions.

In other words, to sit at the table one has to pay a fee. Brazil and Russia have pledged similar amounts as India (as have Mexico and Switzerland). China has pledged more than the other three BRIC nations combined. Remember that it was IMF which bailed India out in 1991 when our forex reserves were near zero.

India’s forex reserves are not stored in some vault in RBI’s headquarters. They are invested mostly in US Treasury bonds that earn a paltry 1.5-2% interest. If and when IMF borrows from India, they are likely to pay a higher amount of interest, say 3-4%. So, a $10 Billion loan to IMF will earn India an extra Rs 800-1100 Crores. A win-win situation for everyone.


Jasi said...

A fantastic post Sir! Very informative. I hadn't got a clue about anything you said in the post. But your post has explained everything so clearly in plain simple English that its harder not to understand it :)

Thanks so much! Keep up the good work!

Subhankar said...

You are always generous with your comments, Jasi. Thanks.

Alkesh said...

Boss, there are two type of loans.. one which comes back and another is dead.. like bad loan.

Loan to europe is all dead...also to America.. usa bills..

India should better use their money

Subhankar said...

Our loan will be to IMF, which in turn may loan it to others. IMF is not known to default on its loans. US may have a balance of payments problem, but not a sovereign debt problem. US Treasury Bills can hardly be called 'bad loans'.

Would like to hear your views on how India can 'better use' their forex reserves. (Contrary to popular belief, converting forex reserves to Indian Rupees is not an option - because we won't have any forex left to pay for imports.)