Fears over India's external debt are overblown
Premium- The composition of India's debt and the country's ability to service it indicate the parallel drawn with Sri Lanka is flippant
The pressure on the rupee and the slide of the Indian currency over the past few weeks to close to the 80 mark to the US dollar has roiled the markets and has many worrying. Adding to that, some analysts and a lawmaker (who is a former bureaucrat) sought to stoke fears pointing at the substantial external debt repayments due this year, with flippant references to neighbouring Sri Lanka which a major debt crisis has pushed into bankruptcy and sovereign default.
The parallel sought to be drawn between India and Sri Lanka is misplaced; the fears are overblown.
The size of India’s foreign debt and its composition and profile, and the capacity to repay the loans by the various classes of borrowers is simply not comparable to the worrying situation in the neighbouring island nation.
Sovereign debt is a small component
India’s external debt or debt denominated mainly in foreign currency was $620.7 billion at the end of March 2002, according to data released by the ministry of finance and the Reserve Bank of India. That is a little more than $47 billion higher than the previous year.
The single largest component of this debt pile is foreign loans at 40%. These are mainly borrowings by companies to finance manufacturing of goods, or to build ports, airports and other infrastructural projects–all largely commercially viable projects.
Banks and other financial institutions too borrow overseas to lend to customers here who are unable to directly access markets abroad. These sort of borrowings account for 25% of foreign debt. Much of this fund-raising is usually in US dollars. There's also some in the Japanese yen and a few other currencies. The average period of maturity is of three years or more.
Over the past decade or more, foreign borrowings by Indian companies has risen with the growth in the economy and a more liberalised policy on such borrowings, and also due to the comfort of sizeable foreign exchange reserves that are still in excess of $550 billion even after the RBI has spent dollars at a hectic pace to slow down the pace of the rupee's depreciation.
The other important components of external debt are deposits by Non-Resident Indians (NRIs) in foreign currency and rupee accounts, besides trade credit, which includes buyer's and supplier's credit. These are short term—well under a year.
Sovereign debt is a small component of the total external debt
It consists of loans drawn by the government from international agencies mostly on concessional terms with a long repayment period. These have largely declined over time and the situation is nowhere close to what it used to be in the 1990s. The share of government debt in overall external debt is just a little over 20 per cent now.
India is fully capable to service its external debt
The lawmaker who made flippant remarks about India's external debt seems to have misinterpreted or misrepresentated the data on the lumpy external debt repayments of $ 267 billion due this fiscal—which is 43.1% of total debt and 44.1% of India’s foreign exchange reserves of $588 billion. At first glance, the juxtaposition of the repayments due and forex reserves stockpile appears challenging. More so at a time when the rupee has come under pressure, with foreign investors in stocks pulling money out to park it in safer and higher yielding investments in the US, and with foreign investments and other inflows, including by foreign venture capital funds, tapering off.
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However, the ability of a country to repay debt on time is reflected in, and assessed through, a few key metrics or ratios. Importantly, they are also linked to the level of foreign exchange reserves which a country holds and the size of its GDP or national income.
Before evaluating India's ability to service its external debt, let's first understand how India’s foreign exchange assets get accumulated. They are built mainly on the back of foreign investment in local companies, portfolio investment either in equities or debt, remittances by Indians living abroad, deposits of NRIs, foreign debt flows, export earnings. These are then invested by the RBI in safe and liquid investments globally which can be put to use swiftly. The central bank uses part of the reserves also to intervene in the market to manage the value of the rupee—to ensure that the rise or fall of the currency is not unduly high and to boost confidence. A high level of reserves can provide a source of comfort for liquidity.
Now let's look at some of the ratios. A key one is the debt-service ratio. That’s the percentage of debt payments (principal and interest on long-term and short-term debt) to exports of goods and services for a year. That means if there is sufficient exports and other earnings, it is quite possible to service debt. That ratio is a 5.2%— a far cry from the days of the 1991 crisis when it was more than 35% and when a large chunk of debt was on the government’s books. Since the 1990s, except for short bursts like during the global financial crisis and the taper tantrum in 2013, many of these ratios have trended lower. Other metrics too are relatively comfortable— such as the level of short-term debt to total debt at 20%, the ratio of foreign exchange reserves to total debt at a shade below 98%, a technical reflection of enough reserves to cover a good part of the debt which has to be repaid or if capital flees. As a percentage of GDP too, it is low at 19.9%, compared to many peers. Many of these ratios were much higher in 2013 and 2014.
No danger of sovereign default
Importantly, India is an outlier compared to most countries in that it has not borrowed in the global bond markets to raise foreign currency like China, Russia, many Latin American countries and neighbouring Sri Lanka. So there isn’t a fear of a sovereign default on a dollar bond repayment or a renminbi repayment, such as Sri Lanka is struggling with. The last such threat was met in 1991, when India had pledged gold holdings to avoid a default on its external obligations.
A sovereign default has a huge impact in terms of sovereign ratings, and in turn the penalty it places in terms of higher cost of borrowings and access for corporate borrowers. That is not the same as a corporate default.
Indian companies can back their foreign borrowing
So with no danger of sovereign default, does India still have reason to worry? Not really. Indian companies have assets and revenue streams to back their foreign borrowings, as the lenders are likely to have assessed. The question is, have they hedged adequately, and at viable costs, for the rapid deceleration of the rupee?
A corporate borrower can either roll over its debt when repayment is due or refinance it— by taking a fresh loan and paying off the old debt with little impact on the foreign reserves. And foreign lenders will lend to Indian firms based on their strength and growth prospects which is why sustained GDP growth is seen as critical. External debt raised by companies supports GDP growth.
A good number of companies do have the ability to repay or obtain refinancing— thanks to their export earnings or balance sheet strength.
Most importantly, the RBI constantly monitors and matches the repayment and maturity profiles of external commercial borrowings and its foreign exchange reserves to minimise mismatch between the assets and the liabilities. Some mismatch is bound to occur even after that but there really isn't cause for alarm.
Even if there is pressure on the rupee and if the central bank draws down part of its reserves in order to support the depreciating currency, it still also has the option of stabilising the currency and replenishing reserves through policy measures. These can be in the form of higher interest rates on deposits by NRIs; allowing more liberal borrowings by Indian companies abroad; and opening up of the Indian debt securities market to foreign investors. A couple of such measures have been announced by the central bank. It is not as if the repayments coming up now will drain the reserves fully as other inflows could well continue unless there is a major global turmoil or ultra-aggressive interest rate hikes globally.
Seen against the factual position, the fears sought to be created about the adequacy of the RBI's forex reserves and the level of the external debt seem overblown and misplaced.
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