External commercial borrowings: Is the Government's overseas debt plan a good idea?

To go the ECB route, the government will need to be prudent to ensure that external risks are kept to the minimum.

July 31, 2019 11:00 IST | India Infoline News Service

External commercial borrowing (ECBs) are loans borrowed by Indian entities from non-residents in foreign currency. ECBs are used widely in India to access foreign money by Indian corporates and PSUs at favorable rates of interest.

The significance of ECBs and their size in India’s balance of payment account is only increasing as they have emerged as a huge avenue for corporates to raise capital at lower than domestic rates.
ECBs may comprise commercial bank loans, buyers’ credit, suppliers’ credit, securitized instruments such as Floating Rate Notes and Fixed Rate Bonds, etc.
The advantages of ECBs are well-known. ECBs allow corporates to borrow a large volume of funds for a relatively long term.
Interest rates are also relatively lower compared to domestic funds.
ECBs are in the form of foreign currencies owing to which they allow companies to have foreign currency for import of machinery, etc.
While presenting Union Budget 2019, FM Nirmala Sitharaman spoke about the easing of ECB norms to make capital available to domestic companies at a time when the economy struggles with liquidity.
At the same time, the budget also announced GoI’s plan to start raising a part of its gross borrowing programme in external currencies.
This was followed with a slew of opinions for and against the idea from some of the most eminent economists.

Let us consider the points below:

  • The government wants to diversify its borrowing, which has so far been limited to the domestic market, and create a benchmark for future bond sales. With global interest rates low and falling, officials see the timing as favorable too. This move aims at reducing public sector borrowings in the domestic market, thus creating space for the private sector.
  • Although the step would integrate the Indian economy in global markets, it is debated that there is high risk involved. The interest rate on the coupon depends primarily on India’s sovereign credit rating, external and internal risk factors, and the rates that our peers currently pay.
  • Presently, global money markets are inundated with liquidity, which is the reason for many emerging economies’ ability to borrow at low interest rates.  Indian government borrows a mere 5% of its GDP in foreign currency, which makes room for the government to borrow more.
  • However, borrowing abroad also makes the country far more vulnerable to currency volatility. If the Indian rupee suddenly drops in value because of an unforeseen event, repaying the debt in dollar terms would become much more expensive for the government. Since GoI will have to pay the interest and principal in rupee terms, depreciation against the dollar amounts to an additional interest charge on the loan.
  • E.g., if the rupee were to depreciate by 3% post fundraising, and if the interest rate offered was 3.5%, the effective cost would be 6.5%.

Thus, to go the ECB route, the government will need to be prudent to ensure that external risks are kept to the minimum.

Also, it is best if the government thinks of this as a rare instance to take advantage of low global interest-rate levels in a bid to ease pressure of domestic borrowings, and not make this a regular practice.

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