BREAKINGVIEWS - Risky borrowing rules show India's growth anxiety

Currency of different denominations are seen in this picture illustration taken in Mumbai April 30, 2012.

SINGAPORE (Reuters Breakingviews) - Less than a month into his new job as the finance minister, P. Chidambaram is in a hurry to rev up the economy's sputtering engines. But with inflation still high -- the rate just dipped below 7 percent for the first time in 32 months -- the RBI in Mumbai is reluctant to help by cutting policy interest rates. So Chidambaram wants to rely on the magnanimity of the US Federal Reserve, the European Central Bank and the Bank of England. He is nudging local companies to take more loans denominated in foreign currencies.

Such borrowing used to be tightly restricted, but the government has been loosening the rules. Mortgage-finance companies recently got the government's blessing to finance low-cost housing with cheaper overseas funds. Manufacturers and those constructing roads or power plants can now replace more of their rupee debts with foreign-currency borrowings.

The short-term savings are substantial. Thanks to near-zero policy interest rates in much of the developed world, highly rated Indian companies are able to borrow overseas funds three to five percentage points below the cost of rupee loans. And in the short term, the practice isn't too dangerous. Official foreign-currency reserves are large enough to repay almost the entire $335 billion external debt, about a fifth of the country's annual output.

Over time, however, a fall in the rupee or a rise in foreign interest rates can turn such loans into a millstone for the borrowers. If recent trends continue, the whole country could get into trouble. While the crisis of 1991, when the Reserve Bank of India basically ran out of hard currency, is far away, the stock of foreign debt has shot up by 32 percent in the last two years even as foreign-currency reserves have fallen.

Chidambaram is chasing poor-quality GDP growth. That's pointless. A more sustainable course would start by slashing wasteful subsidies, speeding up infrastructure projects and implementing a much-delayed goods-and-services tax. None of those steps are easy, but a government that doesn't even try will further undermine investor confidence -- making foreign-currency borrowing even riskier.

CONTEXT NEWS

- Mortgage finance companies in India will be eligible to borrow overseas funds for low-cost housing projects, a ministry of finance committee said in an August 22 press release. Manufacturers and infrastructure companies will now have higher foreign-currency debt limits. The limit on external debt for such companies will rise to 75 percent of the average foreign-currency earned during the past three financial years, or 50 percent of the highest foreign-currency earnings in any of the last three years, whichever is higher, the statement added.

(Editing by Edward Hadas and Katrina Hamlin)

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)