The lure of dollar bonds

Surge in foreign borrowing poses risks

Stress in the financial system and elevated levels of non-performing assets in the banking sector appear to be pushing Indian companies to borrow from overseas. The data compiled by the Business Standard Research Bureau shows that Indian companies raised $13.74 billion through dollar bonds in the first 10 months of 2019, compared with $1.65 billion in the same period last year. This is in line with the data published by the Reserve Bank of India (RBI). The latest Monetary Policy Report, for instance, showed that the flow of funds to the commercial sector practically collapsed between April and mid-September to Rs 90,995 crore against Rs 7.36 trillion in the same period last year. Since the flow from the banking system reversed, Indian businesses turned to foreign sources for funding. Borrowing from external sources during this period was worth Rs 54,073 crore, compared with (-) Rs 653 crore in the same period last year. The commercial sector was also helped by a pickup in foreign direct investment in this period. 

Apart from the banking system’s reluctance to lend due to weak balance sheets, companies tend to borrow  abroad to take advantage of lower rates. It’s not difficult for better-rated companies to raise funds in international markets at a time when investors in advanced economies are desperately looking for yields. However, higher dependence on foreign currency borrowing can increase risks to financial stability. India’s stock of external commercial debt is in excess of $200 billion. Further, short-term debt (residual maturity) is worth 56 per cent of foreign exchange reserves. A higher level of short-term debt can lead to significant volatility in domestic markets if financial conditions tighten in global markets. A sudden spike in oil prices, along with repayment obligations, can significantly increase volatility in the currency market as happened in 2018. A sharp depreciation in the rupee increases the debt burden of companies that borrow in foreign currency without having revenue in foreign exchange. Higher borrowing aboard also puts upward pressure on the rupee. Indian exports have been virtually stagnant over the last few years and the overvaluation of the rupee is cited as one of the big reasons. Since India runs a current account deficit and will need to import capital to fill the savings-investment gap, it would do well to not encourage the flow of short-term debt in foreign currency. Also, the central banks should actively intervene to keep the rupee competitive. 

Moreover, it is important to strengthen the Indian financial system, so that savings can be efficiently channelised into productive sectors of the economy. Although the government is consolidating and recapitalising public- sector banks, it needs to do more to bring them back on track. The government and the RBI also need to allay fears emanating from non-banking financial companies. Friction in the financial system is impeding the transmission of monetary policy and is not allowing Indian businesses to benefit from lower rates. As economist Neelkanth Mishra highlighted in this newspaper, the gap between the average lending rate of banks and the policy repo rate is the highest on record. India needs a more robust financial system to fund the productive sectors of the economy. This will also help reduce dependence on foreign borrowing and strengthen financial stability.