Undue reliance on external finance

Global inflation, the launch of a monetary tightening cycle in the United States with rising interest rates, depreciation of exchange rates and the end of the war in Ukraine, force many countries to borrow to exit balance of payments difficulties.

However, this is not the best time for this maneuver, given the uncertainty that engulfs the global financial system.

Yet one country that seems less affected by these circumstances is India.

Despite the outflow of foreign capital from Indian financial markets in the first quarter of 2022, the stock market has not fared too badly. And the official assessment of the country’s external debt situation is that “external debt continues to be sustainable and prudently managed”. (Quarterly Report on India’s External Debt for the Quarter Ending December 2021, Ministry of Finance, March 2022.)

There are reasons for this confidence. India’s external debt-to-GDP ratio stood at 20% at the end of 2021. This is comfortable and well below the ratios characterizing most oil-importing developing countries.

And the foreign exchange reserves, at 632 billion dollars, seem sufficient to face any eventuality. Thus, while times are tough, India seems to be prepared to face any external shock.

However, there is no room for complacency. Indeed, in the years following the global financial crisis, when easy money policies in developed countries led to an explosion in global liquidity and lower interest rates, India softened its stance with respect to external commercial borrowing by the private sector.

Increase in external borrowing

Given the interest rate differentials between global and domestic markets, Indian financial and non-financial firms have borrowed money abroad to finance their expansion in their country as well as to replace high-cost domestic debt. by cheaper foreign debt. Between end-December 2008 and end-December 2021, the dollar value of India’s outstanding debt rose from $230 billion to $615 billion. Much of this increase was due to commercial borrowing, which rose from $65 billion to $226 billion between those two dates (Chart 1).

This raised the share of external commercial borrowing in total external debt stock from 28.5% at end-December 2008 to a peak of 39.6% at end-December 2019, after which it fell to 36.8% at end-December. . 2021 (Chart 2).

Prior to this surge in commercial borrowing, there was another notable trend in the country’s external debt position. This is a decline in the share of long-term debt in the total, which fell from 95% at the end of September 1999 to 80% at the end of December 2020, after which it fluctuated around this level and set at 82% at end-December 2020. end-December 2021 (Chart 3). If there is a shock that discourages old short-term creditors from rolling over loans and new lenders from providing additional credit, there will be a net outflow of capital from the country.

Moreover, the aggregate level of debt exposure is not the best indicator of the level of vulnerability. A feature of India’s boom years since the early 2000s has been the accumulation of large amounts of debt in the hands of a few large corporations and corporate groups. A quick review of the list of borrowers using external commercial borrowing reveals the same trend.

This is understandable, as small businesses are unlikely to be able to access overseas commercial debt markets at attractive interest rates. Much of this debt has been incurred to invest in activities that are not export-oriented and unlikely to generate dollar-denominated revenues.

Growing vulnerability

Thus, a concentration of this private external debt in the hands of a few large corporations is inevitable. But it also increases the level of vulnerability, especially as the rupee depreciates against the dollar, which is the preferred currency for issuing cross-border international debt.

To the extent that dollar liabilities associated with external debt exposure are not adequately hedged – which, according to reports, they are not – a decline in the relative value of the domestic currency increases the volumes in national currency needed to service this debt. This can, in times of crisis where margins are tight, erode repayment capacity and even lead to default.

But increased commercial borrowing, greater dependence on short-term debt, and concentrated exposure are not the only factors that need to be pointed out when considering external vulnerability. It should also be noted that during the years of liberalization, India has become host to large volumes of mobile capital.

For example, cumulative net legacy investment by foreign portfolio investors in the debt and equity markets fell from $69 billion at the end of March 2008 to $265 billion at the end of March 2022. (This includes part of the external commercial loans mentioned above). .)

This is not a small proportion of the country’s overall foreign exchange reserves. Foreign exchange reserves fluctuate for multiple reasons, including central bank sales or purchases of dollars to support or depreciate the rupee against the dollar.

But it is telling that the ratio of cumulative net portfolio investment in the country to its foreign exchange reserves rose from 29.9% at the end of March 2000 to 66% at the end of March 2015, then fell to 62.5% at the end of March. 2015. -March 2017, 60% at the end of March 2019 and 42% at the end of March 2022.

The decline over the past three years was the result of a surge in reserves from $413 billion at the end of March 2020 to $632 billion at the end of March 2022. But that’s not necessarily because of adjustments that reduced the vulnerability.

On the contrary, two particular factors influencing the level of reserves also seemed to have played a role: the accumulation of reserves due to purchases of dollars by the RBI to curb the excessive depreciation of the rupee, and the transfer to India of its SDR 12.57 billion share of the special SDR 456 billion regime allocated by the IMF in August 2021, which increased India’s reserves by the equivalent of $1.55 billion.

Threat of investor exit

Portfolio investors still account for a large share of India’s “borrowed” reserves, eroding their value as insurance against capital outflows. These are investors who are prone to gregarious exit fairly quickly when conditions worsen in their outlook, whether in the host country or at home.

Unsurprisingly, in the first three months of 2022, when uncertainty over global market conditions and monetary policy adjustments that would be made by the world’s major central banks increased, around $15.5 billion was been taken out of the country by foreign portfolio investors.

If this outflow continues and accelerates, not only would the balance of payments be destabilized, but the currency could depreciate quite quickly, making India’s debt and foreign investment exposure less comfortable than it looks.

Published on

April 04, 2022

Shirlene J. Manley