Last week’s Budget came at a time when higher government borrowing had already seriously hurt corporate investment and thus growth. Unable to sufficiently minimise the Centre’s borrowing next year, the government has tried to open up various routes by which foreign money can help plug the gap for Indian companies. Qualified foreign investors are, for example, to be allowed to participate in the corporate bond market, though that, in the absence of a vibrant secondary market, is unlikely to be enough to invigorate the corporate debt market. It has also opened up a route for borrowing working capital overseas. Airlines will be allowed to borrow up to $1 billion worth of working capital strictly within the time frame of 2012-13. It is questionable if companies with balance sheets as damaged as those of Air India and Kingfisher Airlines will find overseas lenders even if they agreed to huge premiums. However, there could be serious long-term implications of this relaxation. Other industries will lobby for similar concessions. Any increase in vulnerability could lead to severe stress or even a balance of payments crisis.
Working capital loans through the external commercial borrowing (ECB) route could be welcome for many Indian businesses. The interest rate differentials between rupee working capital loans (around 14 per cent) and hard currency loans (between four and six per cent depending on currency) are substantial. A working capital borrower with rupee earnings should be able to, under normal circumstances, hedge the currency risk for three to four per cent and still reap the benefit. Given substantial hard currency earnings (as indeed airlines have), currency risk is reduced. However, during several periods in the past, the rupee has lost (or gained) sharply in a matter of weeks. Such a swing has occurred at least once in each of the past four years. Indeed, this type of volatility is characteristic of currency markets. Foreign exchange rates rarely move in smooth, gradual trends; instead, there are periods of extreme volatility interspersed with those of relative calm.
If a big swing occurs and a large amount of ECB repayment is due, there could be trouble. Hedges are structured and geared to specific rates. If the rate is overshot, the hedge is either no longer operative or, at any rate, ineffective. In such a hypothetical scenario, there will be political pressure on the government to cover external defaults. India has an apparently comfortable reserves position. But it has worsened. Reserves dropped from $322 billion in August 2010 to $292 billion in January 2012. External obligations are about $326 billion. Roughly 30 per cent of that is corporate debt. There is a large trade deficit, and it’s not likely to turn into surpluses, given high crude oil prices. And a substantial proportion of reserves consists of portfolio funding — hot money that could flow out quickly. It would take the coincidence of a series of unfortunate events to create an actual balance of payments crisis. But such did indeed occur in several Asian countries in 1997-98. It led to dramatic devaluations in Indonesia and Thailand and desperate stop-gap measures in Malaysia. It would be foolhardy to assume that it couldn’t happen here.