External exposure and risk

April 5, 2022
Posted by: OptimizeIAS Team
Category: DPN Topics

External exposure and risk

Subject: Economy

Section: External Sector

Context:

Global inflation, the launch of a monetary tightening cycle in the US with increased interest rates, depreciating exchange rates and the fallout of the war in Ukraine are forcing many countries to borrow their way out of balance of payments difficulties.

Concept:

India’s position

India seems less affected by these circumstances due to:

Low external debt-India’s external debt-to-GDP ratio stood at 20 per cent at the end of 2021.
Large foreign exchange reserves– at $632 billion seem ample to handle any contingency.

Issue:

Rise in external commercial borrowing
Easy money policies in the developed countries-given the differentials in interest rates between global and domestic markets, Indian financial and non-financial firms borrowed money abroad to finance their expansion at home as well as to substitute high-cost domestic debt with cheaper foreign debt.
Decline in the share of long-term debt in the total from 95 per cent at the end of September 1999 to 82 per cent at the end of December 2021
Concentrated debt exposure- volumes of debt in the hands of a few large corporations and corporate groups.
Non revenue generating debt-Much of this debt has been incurred to invest in activities that are not export oriented and are unlikely to yield revenues denominated in dollars.
The rupee depreciation vis-à-vis the dollar-likely to increase the value of external debt
Higher Portfolio investors- still account for a large share of India’s “borrowed” reserves. These investors are prone to exit rather rapidly in herd-like fashion when conditions turn for the worse.

Factors making the external debt portfolio stable and also sustainable.

Low reliance on external borrowing and issuance of majority of securities at fixed coupon.
External borrowing from official sources which are of long term and concessional in nature.
Low issuance of short-term bonds with a view to elongate the maturity profile.
Low debt to GDP ratio and low external debt to total debt ratio
High Indian currency denominated external debt
If the Interest Rate-Growth Differential (IRGD), the difference between the interest rate and growth rate, becomes negative, the governments need not worry about deficits since the growth would take care of the interest payment obligations. This would ensure the sustainability of public debts.
Diversified debt exposure
Higher forex reserves

External Commercial Borrowings (ECB) are debts taken on by an eligible entity in India from external sources for strictly commercial purposes, i.e. from any recognised entity outside India.

The Department of Economic Affairs of the Ministry of Finance, in collaboration with the Reserve Bank of India, supervises and regulates ECB guidelines and regulations.

There are currently two methods for using ECB to raise funds: the permission route and the automatic approach.

Automatic route: The government has created a number of eligibility requirements for people who want to use the automatic method of receiving money. These rules govern, among other things, amounts, industries, and the final use of funds.
Permission route: The approval method, on the other hand, necessitates explicit authorization from the RBI or the government before obtaining funds through External Commercial Borrowing.

The RBI has specified the borrowing structure in circulars and formal guidelines.

The RBI has established the categories of “eligible entities” among borrowers and “recognised non-residents” among potential lenders to ensure that the inflow remains clean.