Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Foreign investment in rupee debt

Ajay Shah has written an interesting
about what is wrong with
India’s policy on foreign debt. His most important point is that
India restricts foreign investment in rupee debt while being much more
liberal about Indian companies borrowing in foreign currency
internationally. I agree with Ajay Shah that this is truly absurd but it
is fully explained by the political economy of the situation. The
corporate sector usually gets what it wants through intensive
lobbying. This happened in East Asia before the crisis and it is
happening in India now.

We should work towards getting rid of ‘original
sin’ and replacing foreign currency debt with rupee debt. There
are though two caveats. First if foreign investors are
allowed to hedge currency risk, then the true national exposure may
still be that of foreign currency debt if it is an Indian entity that
stands on the other side of the hedge. In fact, the effective position
of the nation can be that of short term foreign currency debt. This
problem is not insurmountable but some thought needs to be given to

Second, as Martin Wolf points
, many countries have been able to
overcome ‘original sin’ and borrow in their own
currencies “once they have persuaded their own citizens to lend to
them”. We need a proper government debt market instead of the captive
market that we have now.


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