(Weekly Organ of the Communist Party of India (Marxist)
October 23, 2011
Danger of Debt
C P Chandrasekhar
THIS July marked the completion of two decades after
Fear of default due to inadequate access to international liquidity was the proximate cause. What was surprising, however, was that this occurred in a context where the country’s external debt to GDP ratio was by no means alarming. In the year 1990-91, the external debt to GDP ratio was jus 29 per cent, which was moderate when compared to the levels that indicator had reached in
It is in this light of that experience that recent trends in
external debt Even foreign institutional investors are showing a preference for the
debt market. Between 2009 and 2010, while equity investments by FII's rose from Rs 83424 crore to Rs 133,266 crore, investments in the debt market rose from a measly Rs 4563 crore to Rs 46408 crore. Clearly Indian debt is an attractive investment destination.
Five factors, among others, have been principally responsible for this trend. The first is that the period since 2003-04 has been one in which there has been a supply-side driven surge in capital flows to emerging markets worldwide, and
Needless to say, Indian corporates were quick to exploit this opportunity. They chose to borrow from international markets, since they could obtain credit at rates lower than available in the domestic market, especially during the period when domestic interest rates were on the rise. Many firms even chose to pay-off past debt mobilised in domestic markets and replace it with borrowing from abroad. Two factors favoured this tendency of accelerated, external-debt accretion. One was that, since this was a period when GDP was rising fast, the accretion of debt did not result in any significant increase in the external debt to GDP ratio. Thus over the period starting 2002-03, the external debt to GDP ratio fluctuated in the 17-20 per cent range, which would be considered acceptable. The other factor was that the surge in capital inflows into the economy over this period had strengthened the rupee. In fact, the rupee had to be prevented from appreciating too much through central bank purchases of foreign currency, leading to the observed build up in reserves. This meant that domestic borrowers taking on debt service commitments in foreign exchange terms did not fear that a depreciation of the rupee vis-à-vis the dollar, for example, would substantially increase their debt servicing burden in rupee terms. The result was a borrowing spree.
however, is that the rapid increase in the absolute volume of
external debt is
occurring in a context in which
According to one estimate (Business Standard, October 10, 2011) the fall in the value of the rupee since August would increase the redemption cost on foreign currency convertible bonds issued by 30 companies that are maturing over the next 12 months by as much as Rs 500 crore, from around Rs1500 crore to Rs 2000 crore. Thus the sudden increase in the quantum of exposure to external debt can render corporations vulnerable, even if the economy as a whole is not. But even when it comes to the economy there are some reasons for concern. As noted earlier, at the time of the last debt-driven balance of payments crisis, the run up to the crisis was characterised by a rise in the share of short-term debt in aggregate external debt. In 1990-91, the inability to refinance a significant volume of short term debt prior to the crisis had brought its share in the total down to 10.2 per cent. Having burnt its fingers, the government made an effort to reduce dependence on such debt, so that its share came down to as low as 2.8 per cent at the end of March 2002 . Since then however dependence on short term debt began to rise, and that tendency has got strengthened during the period when aggregate external indebtedness has been accelerating. In the event, the share of short-term debt to aggregate debt stood at 21.6 per cent at the end of June 2011. This increase in the proportion of short-term debt could reflect the fact that international lenders are increasingly wary about lending long to
The official understanding seems to be that this is unlikely to happen and even if does, the situation can be managed given the large reserves available with the RBI. This may be too sanguine a perspective. Consider for example the relationship between the level of foreign exchange reserves and the magnitude of external debt outstanding. After having risen from 42 to138 per cent between 2001 and 2008, the ratio of foreign reserves to external debt has fallen and stands currently at close to unity.
There are two messages that can be read into this picture. Since these foreign reserves were accumulated during a period when
It could, of course, be claimed that long-term debt cannot be withdrawn too quickly, and their amortisation can be planned for. The difficulty is that the ratio of short-tem debt to foreign exchange reserves at 21.7 per cent is close to the mid-1990s level from which it had subsequently collapsed. Together with accumulated portfolio liabilities they amount to three-fourths of available reserves. If a significant chunk of this capital is withdrawn from the country, the effects could be destabilising, even if not similar to the one in 1991, when reserves could finance only half a month worth of imports.