Piling foreign debt

New ECB norms can make India more vulnerable to external shocks

The revised norms for end-use of money raised through external commercial borrowings (ECBs), announced by the Reserve Bank of India (RBI) on Tuesday, have brought in significant changes. Under the new norms, ECBs with a minimum average maturity period of 10 years can be used for working capital and general corporate purposes as also by non-banking finance companies for on-lending. The RBI, in consultation with the central government, has also permitted firms to raise ECBs for repaying rupee loans taken from domestic sources for capital expenditure in the infrastructure and manufacturing sectors, classified as SMA-2 or non-performing asset (NPA), in order to make a one-time settlement (OTS) with lenders. Besides, banks have been allowed to sell such loans to eligible foreign lenders. At the company level, the revised norms can potentially help raise funds more freely from external sources. Since the Indian banking system is still struggling with NPAs and may not be in a position to fund the requirement of the Indian corporate sector, the new norms will enable companies to diversify their borrowings.

The possibility of Indian companies borrowing overseas to repay domestic lenders will also enable banks to lend to smaller businesses which are not in a position to borrow from external sources. In view of the fact that the cost of money in the global financial markets is expected to come down further, some companies may be able to reduce their interest burden by borrowing abroad or by swapping their rupee loans with foreign-currency debt. But they will need to carefully manage the currency risk. Also, instead of heading for the Insolvency and Bankruptcy Code (IBC) solution, banks and companies can now get into an OTS scheme, the funds for which have to be raised abroad. 

The latest move appears to be part of an overall strategy that Indian companies should tap global resources to lower cost. However, potential benefits at the company level should not make policymakers lose sight of the broader macro picture because increasing reliance on foreign capital can be dangerous. It is correct that there are problems in the Indian financial sector and the corporate balance sheet is also stressed. But depending on foreign debt to address some of these issues can exacerbate difficulties for India and should be avoided. For instance, higher foreign borrowings would put upward pressure on the rupee, which anyway is excessively overvalued, and affect exports. The other problem is the reluctance of Indian companies to hedge their risks. Unhedged exposure can become a threat not only to individual companies, but to the system and its stability. Experience in many countries have shown that corporate crisis can turn into a macro-economic risk in no time.

Further, this will increase India’s foreign debt exposure and, in the absence of consistent inflows, servicing can become a problem. This can result in significant volatility in the currency market and, among other things, increase the repayment burden for Indian companies. India’s foreign debt which needs to be repaid by the end of this fiscal year is over 43 per cent of the total external debt and 57 per cent of foreign currency reserves. This is not to suggest that India should not tap foreign funds to supplement domestic savings. India should target higher direct equity investments, which are more stable and will help augment growth. Increasing dependence on debt, as the relaxation in ECB norms shows, will make the Indian economy more vulnerable to external shocks and increase risks to financial stability.