No external debt crisis, please

The Reserve Bank of India (RBI) recently issued a curious circular to all banks in India. It barred banks with overseas operations from giving foreign currency loans to Indian companies. It has also stopped them from providing Indian companies with guarantees that help raise loans from other overseas banks, so that they can repay outstanding rupee loans in India.

What’s intriguing about this notification is that it revokes a 2012 decision, which allowed Indian companies to raise money overseas to repay rupee loans.

But, when viewed in conjunction with a few other recent policy measures, a clearer picture emerges of the RBI’s attempts to fashion external policy — one that attempts to limit the Indian economy’s vulnerability to external volatility that may arise from the US Federal Reserve’s tapering policy.

There is, of course, the RBI’s obvious concern about the swelling non-performing assets (NPAs) on bank books. NPAs pose an impending risk to the banking system and the economy and, if left unresolved, could damage the credit markets for a long time. In January 2014, the RBI even released a framework for revitalising distressed assets.

The International Monetary Fund (IMF) too, in its latest instalment of Asia Pacific Economic Outlook , has struck a cautionary note about the high proportion of corporate NPAs, which it feels are a threat to economic stability. According to the Outlook , a third of India’s corporate debt belongs to highly leveraged companies — with a leverage of three times or more (for every Rs 100 of share capital, these companies borrowed Rs 300 or more), the highest leverage in the region.

Unfortunately, many of these companies also have a low profit-to-interest-payment ratio, also known as interest coverage ratio (ICR); meaning, they have few profits left, after taking care of operating costs, to pay interest and taxes.

The IMF report further says that for companies with external borrowings, any currency depreciation is likely to hit the ICR. And this is probably what’s giving the central bank anxious moments. There are clearly two strands to the RBI’s external strategy.

At a broader, macro level is India’s total external debt position, which amounted to $425.9 billion in December 2013 — a jump of 13.2 per cent from $376.2 billion in December 2012. India’s external debt has been rising — especially since the apex bank started raising benchmark interest rates to counter deeply-embedded inflationary trends. This prompted many companies to tap cheaper external markets for loans.

Commercial borrowings currently total $134.229 billion — a jump of over 90 per cent since December 2009: it was after January 2010 that the RBI increased interest rates 13 times in 18 months. Even NRI deposits saw a spectacular rise, especially after the central bank aggressively campaigned for them — starting in September 2013 — to counter the steep rupee depreciation.

NRI deposits amounted to $98.639 billion in December 2013, a clear increase of 107.7 per cent over the $47.490 billion in December 2009. These NRI deposits need to be repaid over the next two-three years.

The rising external debt number is bound to induce a sense of foreboding when viewed through the prism of critical macro ratios — the RBI’s total hoard of foreign exchange reserves can now service only 69 per cent of external debt (compared with 138 per cent in 2007-08), the total outstanding is 23.3 per cent of GDP (it has always been lower than this since 1998-99), and concesssional debt comprises only 10.6 per cent of total debt stock (which means a higher debt servicing burden).

Clearly, one of the objectives of the circular mentioned above — apart from avoiding the cosmetic transfer of risk from the domestic balance-sheet — is to keep a lid on external debt, especially since tapering by the US Fed Reserve is likely to keep the external economy volatile. Allowing Indian companies to raise funds overseas to repay domestic debt might aggravate the situation now.

The second purpose of the circular is to address the probable risks that might arise from short-term external debt, or loans to be repaid within 12 months. Short-term debt was 21.8 per cent of total debt as of December 2013, and is lower both as a percentage of total outstanding external debt as well as in absolute numbers compared to the immediate preceding months.

The country’s stock of short-term external debt touched $92.707 billion at end-December 2013, or close to 21.8 per cent of the total debt, compared with $91.881 billion in December 2012 comprising 24.4 per cent of total external debt then.

What could be worrying the RBI is the rush of money streaming into short term debt instruments — such as 91-day treasury bills issued by the government or commercial paper floated by companies. Such a deluge could be facilitated both by the interest rate differential between western markets and India, as well as the stronger rupee vis-à-vis the dollar.

One of the clear indicators to central bank strategy was revealed in RBI Governor Raghuram Rajan’s first bi-monthly policy statement of April 1. The RBI announced that henceforth foreign portfolio investors will not be allowed to invest in any government security, including treasury bills, with maturity less than a year. While the ceiling for investments in government securities remains fixed at $30 billion, the RBI wants it invested entirely in government paper with maturity of more than a year.

This, the bank hopes, will deter the yield-chasing, short-term investors and insulate the economy from volatility. To soften the blow, the apex bank has handed out portfolio investors a number of sweeteners that facilitate the process, and lower the cost, of investing in the Indian capital market.

One, portfolio investors can now open a local bank account and transfer investible capital into that account directly, unlike the earlier tedium of having to route funds through a custodian bank, which widened the time lag between intent and investment.

Also, portfolio investors can now hedge their currency risks in local exchanges, provided their investments are in government debt of more than 12 months maturity. This is bound to lower their costs, apart from providing them further inducement to invest in Indian paper.

The RBI’s moves clearly show its determination to keep a leash on short-term external debt. One of the reasons, forwarded by India Ratings, could be a rush for the exit by short-term lenders during the tumultuous and volatile period for the rupee between May and August 2013. At the same time, the RBI has shown it does not want to give up on foreign portfolio investors yet, especially given the enduring nature of the economy’s current account deficit.

The writer is Senior Geo-economics Fellow, Gateway House