Economics Prelims cum Mains

Is external debt a cause for worry?

The News

  • A data from the RBI shows that India’s external debt has crossed half a trillion mark to touch a record $513.4 billion as of December 2017, which is an increase of 8.8% since March 2017.
  • Most of it i.e. 78.8% of the total external debt ($404.5 billion) was owed by private businesses which borrowed at attractive rates from foreign lenders.
  • The size of external commercial borrowings and foreign currency convertible bonds, which represents Indian companies’ foreign borrowings, has risen from ₹99,490 crore at the end of December 2015 to ₹1, 72,872 Cr at the end of December 2017.

 

About External debt and India’s status

  • External debt is the money that borrowers in a country owe to foreign lenders.
  • India’s external debt was $513.4 billion at the end of December 2017, an increase of 8.8% since March 2017.
  • While external debt may be denominated in either the rupee or a foreign currency like the U.S. dollar, most of India’s external debt is linked to the dollar.
  • As of December 2017, about 48% of India’s total external debt was denominated in dollars and 37.3% in rupees.
  • This means Indian borrowers will have to pay back their lenders by first converting their rupees into dollars.

 

Background

  • The raising of interest rates by the U.S. Federal Reserve has already caused borrowing rates to rise in various countries, including India.
  • Various emerging market currencies have seen a sharp fall in value this year against the dollar.
  • The rupee, in particular, has fallen about 7% since the beginning of the year.
  • Forex reserves with RBI was at $425 billion as on March 2018, which is around 82.8% of the total external debt with about 53% of debt coming up for maturity in the next one year.

 

Concerns associated with rising external debt

There are two major risks involved in foreign borrowings:

  1. Unexpected changes in the interest rate: There could be unexpected hike in the interest rates charged on these foreign loans, which can cause widespread default, as borrowers may not be able to make higher interest payments, thus raising the risks of a systemic crisis.
  2. Unexpected changes in the exchange rates: Unexpected fall in value of rupee can cause severe difficulties for Indian companies, as they will now have to shell out more rupees than they had estimated to buy the necessary dollars to pay back the dollar denominated loans.

 

Potential additions in the risks associated

  • The U.S. central bank, which has already raised its benchmark interest rate twice this year, is expected to raise rates two more times in the rest of 2018, which could cause more outflow of capital from the emerging markets, thus causing unexpected changes in borrowing rates and the value of the rupee.
  • Both government and non-government borrowers in India, who are exposed to foreign debt, could be in trouble in such a scenario.
  • Also, the RBI, which raised its benchmark interest rate for the first time in more than four years, may also raise domestic interest rates further, which could on the one hand help to stem the capital outflow from the country and support the rupee, but on the other hand could lead to further uncertainty about borrowing rates in the domestic economy.
  • Soaring foreign debt and a deteriorating currency account is bringing back the memories of a currency crisis in 2013.
  • More than half the amount of external debt is coming up for repayment in the next year is a bigger cause of worry for investors and could lead to volatility in a market that is already getting whipsawed by the global trade wars.

 

Way forward

  • The foreign exchange reserves, held by the Reserve Bank of India (RBI), of around $425 billion as on March 2018, is the firepower that the RBI can use to support the rupee and bail out borrowers who get into trouble.
  • At first the situation it may not appear to be in a crisis state as it was in 2013 when the currency was pummeled, but absence of corrective measures could see Indian financial markets witness wild swings.
  • Hence, it’s true that the value of rupee has fallen and external debt has increased, however, the story is not as alarmist as in 2013 and continuance of measure to reduce inflation and fiscal slippages on a sustained basis along some export promoting measures can keep confidence in India fundamentals intact.

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