State Bank of India should have seen it coming. The Reserve Bank of India had forced it to tighten provisioning because of teaser housing loans and other factors, and SBI’s capital adequacy ratio had therefore fallen to 12 per cent in March, from 14.3 per cent two years earlier. To make matters worse, profits have been falling. So when Moody’s cites poor asset quality and reduced capital adequacy as the reasons for dropping SBI’s rating from C- to D+, it is an entirely understandable step. The SBI management has sought to downplay the impact of the downgrading, and it is true that its problem is not systemic and the immediate fallout may be limited, especially since the bank continues to enjoy investment grade rating. But the fact is that somewhere between a fifth and a sixth (that is, over Rs 1 lakh crore) of the bank’s funding is through Tier-II bonds and foreign loans, which will become more expensive by about 30 basis points when the time comes to roll them over. The bank’s share has already lost much more than the general stock market in 2011 (in part because of the rise in yields on gilts as the central bank has raised policy rates several notches), and further losses vis-à-vis the leading market indices cannot be ruled out. The government says it is committed to strengthening the bank’s capital base by infusing fresh capital during this financial year, and that assurance needs to be given afresh.
The impact of the downgrade will go beyond SBI, of course. Some other (state-owned and private) banks that have overseas operations may also come under scrutiny. Corporate India too will feel the impact. External commercial borrowings by Indian companies now total something like $100 billion, and have been climbing rapidly — accounting in the process for the bulk of the increase in the country’s external debt in recent years. Such borrowings have become more expensive, after the rupee’s 10 per cent fall against the dollar in recent weeks, and may already have gone out of fashion. One question is how much of the corporate borrowing has been adequately hedged; by some accounts most of it is, and much of the rest is automatically hedged on account of dollar revenue flows. If such is indeed the case, questions will arise only at the time of debt roll-over, and a possible switch to domestic funding. Will enough of such funding be available at reasonable cost at a time when the government is increasing its market borrowing programme?
Another point of worry is burgeoning trade credit (approaching $40 billion). Given the financial uncertainty in global financial centres and the possibility that fresh lending may be affected, the availability of such credit may become more problematic and result in a drawdown of foreign exchange reserves. Given these uncertainties, the time may have come for adopting a more cautious approach to the country’s foreign debt exposure, in part because external debt has raced ahead of the level of foreign exchange reserves in the last couple of years. Inevitably, this raises some tentative questions with regard to the large and growing current account deficit, the erratic trends in foreign direct investment, and the stability of the country’s external account.