Is Ja­pan’s bul­let train loan the best deal In­dia has ever had?

Mint Asia ST - - News - B Y TA DIT KU NDU

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Min­is­ter Naren­dra Modi high­lighted the fact that Ja­pan had of­fered In­dia a 50-year loan at just 0.1% in­ter­est to fund the Ahmedabad-mum­bai bul­let train link when he in­au­gu­rated the project with his Ja­panese coun­ter­part Shinzo Abe in the Gu­jarat city ear­lier this month. Any­one told of the terms of the loan may not be­lieve “this thing,” said Modi. It is good to be gen­er­ous in praise of vis­it­ing for­eign dig­ni­taries. How­ever, the re­al­ity might be dif­fer­ent and the loan of­fered by Ja­pan may not be as “un­be­liev­able” as Modi claimed.

Gen­er­ally, coun­tries tend to in­vest abroad when they run out of op­por­tu­ni­ties to in­vest at home. This is the rea­son in­vest­ment of­ten flows from de­vel­oped to de­vel­op­ing coun­tries. While in­vest­ments in large-scale in­fra­struc­ture projects might some­times be strate­gic, lend­ing coun­tries of­ten make sure that the funds are used to pro­cure ma­te­ri­als and ser­vices from the donor coun­try. Anal­y­sis of Ja­pan’s lend­ing to In­dia shows that it has not aban­doned this prin­ci­ple. Al­most a quar­ter of Ja­pan’s lend­ing to In­dia since 1982 for rail­way projects has been “tied”, i.e. it man­dates pro­cure­ment from Ja­panese sup­pli­ers, ac­cord­ing to in­for­ma­tion avail­able from the web­site of the Ja­pan In­ter­na­tional Co­op­er­a­tion Agency (JICA), the Ja­panese gov­ern­ment arm co­or­di­nat­ing such projects. Even in projects which are marked “un­tied”, like the Delhi Metro, a large num­ber of con­tracts have been awarded to Ja­panese com­pa­nies ( bit.ly/2fr94w4).

More­over, the ap­par­ently con­ces­sional rates of in­ter­est at which Ja­pan lends for such projects ap­pear less re­mark­able when com­pared to the pre­vail­ing in­ter­est rates in Ja­pan. For ex­am­ple, when Ja­pan pro­vided 30-year loans for the Delhi Metro project in 1997 at an in­ter­est rate of 2.3%, its own 10-year do­mes­tic risk-free in­ter­est rate was also around 2.3%, i.e. the yield on the 10-year Ja­panese gov­ern­ment bond (JGB).

Since then, Ja­pan has seen pe­ri­ods of eco­nomic re­ces­sion, de­fla­tion and in­ter­est rate In­ter­est rates on loans from Ja­pan have his­tor­i­cally been near 10-year JGB yield (%) Rate of in­ter­est on rail­way-re­lated loan ver­sus pre­vail­ing in­ter­est rate in Ja­pan Loan In­ter­est rate (main por­tion) cuts by the cen­tral bank. Con­se­quently, the 10-year yield has fallen from around 2.3% in 1997 to 0.05% to­day. Thus, it is no co­in­ci­dence that to­day Ja­pan is ready to fi­nance In­dian rail­way projects at 0.1% ( see Chart 1).

Of course, such an of­fer for a 50-year loan should still be deemed con­ces­sional be­cause it is cheaper than the yield on the 30-year JGB, which is at around 0.9%.

More­over, the 50-year re­pay­ment pe­riod in it­self is much more gen­er­ous than the 30-year loans that Ja­pan has gen­er­ally pro­vided for rail­way projects.

How­ever, the dis­count on in­ter­est rate is nei­ther ex­cep­tion­ally large nor un­prece­dented. Thus, Ja­pan’s lat­est of­fer does not ap­pear truly un­be­liev­able when seen in per­spec­tive. Ja­pan’s re­cent over­tures ap­pear to be driven by its own do­mes­tic eco­nomic com­pul­sions, with a slow­ing econ­omy forc­ing it to look for in­vest­ment av­enues abroad. Ja­pan had re­port­edly made a sim­i­lar of­fer of bul­let trains to In­done­sia too, of­fer­ing fi­nance at 0.1% ( bit.ly/2k2btiv).

This is not the first time that In­dia has ben- 10-year JGB* yield 30-year JGB* yield efited from the largesse of other coun­tries for projects of na­tional im­por­tance. For ex­am­ple, the Opec Fund for In­ter­na­tional Devel­op­ment funded the Bom­bay High off­shore project with loan agree­ments signed be­tween 1981 and 1982 at an ef­fec­tive in­ter­est rate of 0.75% re­payable over 20 years.

The rate of in­ter­est was much lower than the pre­vail­ing 10-year US trea­sury in­ter­est rate of around 13% in 1981-82.

Sim­i­larly, Rus­sia in 1998 pro­vided Dol­lar­de­nom­i­nated credit of up to $2.6 bil­lion for the Ku­danku­lam nu­clear power sta­tion. The loan car­ried an in­ter­est rate of 4% per an­num, lower than the then pre­vail­ing in­ter­est rate of 5.25% on a 10-year US Trea­sury bond. The re­pay­ment pe­riod was around 15 years.

Thus, the re­cent loan agree­ment on the bul­let train only rep­re­sents a con­tin­u­a­tion in the long his­tory of bi­lat­eral ex­ter­nal as­sis­tance on con­ces­sional terms.

Bi­lat­eral as­sis­tance—like that from Ja­pan, Ger­many, Rus­sia and so on—is of­ten much cheaper com­pared to loans from mul­ti­lat­eral agen­cies like the Asian Devel­op­ment Bank High ex­po­sure to yen might pose cur­rency risk: 2008 fi­nance min­istry pa­per Out­stand­ing ex­ter­nal debt of the gov­ern­ment of In­dia Oth­ers (5.62) (ADB) and the World Bank’s In­ter­na­tional Bank for Re­con­struc­tion and Devel­op­ment (IBRD), ac­cord­ing to a min­istry of fi­nance po­si­tion pa­per in 2008, au­thored by then fi­nance sec­re­tar y D. S u b b a Rao ( bit.ly/2wu4vfj).

How­ever, the pa­per also noted that Ja­pan ac­counts for a quar­ter of In­dia’s sov­er­eign debt port­fo­lio and warned: “In­dis­crim­i­nate bor­row­ing in yen will scale up our ex­po­sure to yen, thereby in­creas­ing the cur­rency risk”.

Such risk can be hedged, but it en­tails a large cost; pre­vail­ing mar­ket con­di­tions would sug­gest a cost of 4-5% per an­num, in case hedg­ing is car­ried out through sim­ple for­ward con­tracts.

Adding 4-5% cost would largely de­feat the pur­pose of low-in­ter­est loans from abroad. How­ever, there ex­ist more in­no­va­tive ways to hedge through op­tions. Although the ru­pee has strength­ened against the yen in the last few years ow­ing to large scale quan­ti­ta­tive eas­ing by the Bank of Ja­pan, In­dian au­thor­i­ties should re­main vig­i­lant be­cause cur­rency mar­kets are of­ten un­pre­dictable ( see Chart 2).

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