Then they can pay it back in weaker dollars. It will cost fewer rupees that way. As long as they take the dollars now, and convert them to rupees right away, they will be way ahead when they start paying back.

Maybe the World Bank is insisting on rupees rather than dollars.

Sorry Andrew, have to disagree with the suggestion that the declining USD has to deal (at least exclusively) with the subprime mess. Comparing the USD with all major currencies, the large dropoffs began March 2003, immediately following the invasion of Iraq. The subsequent deficits (budget, trade) and the ongoing war spending is what has made the USD steadily decline.

If anything, when comparing the USD to the Canadian Dollar and British Pounds, the US Dollar has strengthened over the last few months, despite the subprime mess. This is coming off of steady declines for almost 5 years and multi-decade lows, directly associated with war spending and deficits.

Looking at any currency charts, March 2003 was the tipping point, the subprime has had much less (if any) impact; it's only that public awareness of the weak dollar has peaked during this period...

Otherwise, great to see India profiled so positively!

you're not the only suggesting I misinterpreted the significance of the World Bank Loan. I've added a update to the post and changed the headline slightly.

1) The transaction costs of converting from USD to rupees and back might be very high. Given the possibility that the Indian government might try to put controls ala China on the rupee to arrest its appreciation (which hurts Indian exporters, of course), the state may very much want to avoid thos transaction costs.

2) However, if the national government does not put controls on the rupee, the state may not want to bother with the volatility risk (which could be hedged, but that brings in even more transaction costs.)

Because compared to prior disasters like the S&L debacle and the crash of 87 the sub prime problem is fairly minor. The investors who played in it will get hurt but in real terms....not so much.

Between the borrowing and repaying will be a spending stage where they apply the money to whatever purpose the loan was requested for. With a government debtor, it could be a longer term spending plan as opposed to one instant expense. If they keep the loan as dollars, and then the dollar drops vs the rupee, their ability to purchase any local services or materials (in rupees) decreases. It would be possible to both fail to achieve the goal of the project AND be on the hook for a loan that can't be paid back without raising taxes. If I were in charge of that project, and worried about the dollar dropping, I'd consider that an unnecessary risk.

Sure they could immediately convert the dollars to rupees and then spend them later, but they'd pay a conversion fee they could avoid if the loan were directly in rupees.

I am confused. Why would Maharashtra want to borrow in an appreciating currency albeit its own? Would not a US$ loan provide a welcome opportunity for India to offload its foreign reserves held in US$ which are plummeting in value? What am I missing here?

sona

Maharashtra's financial managers may well expect the dollar to continue its decline against the rupee. However, if they're using the standard macro models, downside dollar volatility also implies potential upside volatility -- and they would have the example of the 1997-98 Asian crisis to look back on.

Given that the state's income stream is totally or very largely in rupees, it makes all the sense in the world for them to want to borrow in rupees.

The real story is that they are now able to do so, which implies that India's central bank now has as much or more economic credibility than the Federal Reserve.