BackThe danger in external debt
This growing pile of external loans can prove to be an albatross around the neck for Indian firms in a year when the US Fed, looks like, will finally raise rates
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India’s external debt at the end of December 2014 rose to $461.9 billion, up $15.5 billion from March 2014. Here’s the good news first: As a percentage of gross domestic product, the debt is 23.2%, a 50 basis point decline from nine months earlier. But the increase was tempered by valuation gains of $14.4 billion. That means but for these foreign exchange changes, the rise in external debt in the nine months to December would have been nearly $30 billion.
The second piece of good news is that short-term debt declined to 18.5% of total external debt at end-December compared with 20.5% at the end of the previous fiscal year.
The rise in total external debt has been fuelled by a private sector loan-raising spree. While government external debt has remained stable for some time now, private sector debt has increased steadily to hover around 19% of the country’s economic output.
With the US Federal Reserve and European Central Bank turning on the liquidity tap at a time when domestic interest rates remained high, Indian firms have been raising money mainly from external commercial borrowings. This source of funds makes up 37% of total debt compared with 31.7% a year earlier.
This growing pile of external loans can prove to be an albatross around the neck for Indian firms in a year when the US Fed is likely to finally increase interest rates.
“While not an immediate flashpoint, these borrowings could come under pressure amid an unexpected dollar surge or a jump in rates," wrote Radhika Rao, an economist with DBS Research. The dollar is the favourite currency of India’s external loans, accounting for 58.7% of foreign credit. Secondly, as the Reserve Bank of India has pointed out earlier, many of these foreign loans are not properly hedged. Central bank data shows that by late 2014, about 85% of the borrowings were exposed to currency swings compared with 50% earlier.
While the central bank has been building up forex reserves, these are still inadequate. By end-2014, these reserves were enough to cover just 69.4% of the total external debt compared with 138% in March 2008. This coverage is the lowest in Asia, according to DBS.
While a declining current account deficit and increasing reserves do provide a level of comfort unseen in the previous couple of years, any period of currency turbulence can spell danger for the fragile recovery in corporate earnings.
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