Forex debt deserves more attention

When Viral Acharya, a globally acclaimed banking expert, was recently appointed deputy governor of the Reserve Bank of India, it sent more than one signal about the thought process of Indian policymakers. Prima facie , one would have thought it was a signal that India could still attract global experts to work in domestic policy-making — after the not-so smooth exit of Raghuram Rajan from the governorship.

At a more substantive level, the Acharya appointment also signalled the urgency to tap global expertise to find a solution for the bad loans crisis afflicting Indian banking now.

The mission-mode focus on the stressed (rupee) loans of Indian banking is certainly very welcome given that it is in the corporate industrial sector that the level of stressed bank loans is highest (25 per cent of all loans to this sector).

At the same time, though, it is surprising how the public debate has missed out on the foreign exchange component in the total debt of the corporate sector.

If the rupee loans of the corporate sector from Indian banks are stressed or debt servicing is only piecemeal or sporadic (as a Credit Suisse report on the low interest coverage of a sample of 3000 companies indicates), the problem will be equally or even more severe with respect to the forex (FX) component of the total debt — for the following reasons.

First, it is the size of the commercial FX debt. At between $180 and $200 billion (depending on classification of certain debt items), commercial FX debt in rupee terms is about 60 per cent of the total bank (rupee) credit to the medium- and large-scale industry, or ₹22,00,000 crore. ( Total debt of the medium-/ large-scale industry is therefore approximately ₹36,00,000 crore).

Second, the same strains on and paucity of operational earnings, and the inability therefore to service the bank debt load is applicable with respect to the FX component of the total debt also.

But by far the strongest factor that makes FX debt as much of an evil as the rupee bank debt is the fact that much of it (FX debt) is unprotected or unhedged against unfavourable currency movements. Given the size of the debt stock, this is potentially a systemic risk factor that can damage the credit risk profile of the country itself, going beyond individual companies.

Official data on the level of unhedged forex debt of the corporate sector is not available. But policymakers in India have now and then in public expressed their dissatisfaction at the low level of hedging of corporate forex exposures.

India Ratings & Research recently said ( BusinessLine , January 25, 2017) that nearly 65 per cent of the total ₹19,50,000-crore or $290-billion gross forex exposure of India’s top 100 overseas borrowers was unhedged. It also noted that companies in the oil and gas, metals and mining, power and telecom sectors made up 75 per cent of the $290 billion. (As can be seen, the figure quoted by India Ratings is higher than that indicated as external commercial borrowings in the RBI’s external debt statistics).

India’s RBI has factored in unhedged forex debt in determining credit risk factors in the capital adequacy computations. A corporate with unhedged forex debt attracts a higher credit risk charge and the bank loans to this corporate suffer a higher capital charge (and consequently higher lending rate).

But if RBI officials’ comments and the India Ratings report is any indication, these have not had much impact.

As in any other situation in economics, here too what is missing is the incentive that can drive desired economic behaviour. And as in other areas, it is the responsibility of the policymaker to create the appropriate incentives so that desirable behaviour (much enhanced FX hedging) is generated.

In this context, it may be reasonable to ask if India’s RBI by its repeated pledges — over the past at least 15 years — to maintain “orderly” conditions in the FX markets and “limit” volatility has spawned a certain complacent behavioural approach in corporate hedging.

The poignant point to note here is that despite those pledges, it is not that the rupee has been steady enough to make non-hedging a profitable strategy for Indian companies.

Time and again, the larger macroeconomic imbalances created by that pledge have forced the RBI to abandon it (pledge) — resulting in acute disorder and steep rupee deprecation in the markets and consequently immense financial strain for companies. Developments in 2007-08 and more recently, the 2011-13 experience and the current (2016-17) phase of highly controlled range-bound movements are clear examples.

The first step towards creating a proper incentive structure is to permit wide two-way movements in the rupee.

That can be achieved only if the RBI consciously desists from that “orderly” pledge and follows that up by keeping away from the markets. Wide two-way moves will automatically incentivise at least a part of the overall unhedged universe to come into the market to hedge. Imagine an ECB borrower who has raised funds when the rupee was, say, 67.50 and leaves it unhedged (very much the case as the India Ratings report implies).

If in a “free” market situation, the rupee rises to, say, 62.50, the borrower obtains excellent levels to hedge out his debt completely. There are both conventional and slightly more complex market instruments to do that.

If a corporate treasurer can opportunistically seize such market opportunities — provided they are available — he can end up with a total cost of funds that may be in very low single digits — which incidentally is the objective in leaving FX debt unhedged in the first place!

The writer is a Chennai-based financial consultant