The MS Sahoo committee is right in recommending the easing of rules for borrowing through the external commercial borrowing route to make additional resources available to fund-starved Indian firms. But since these borrowings expose firms to currency volatility, the Centre should wait for the derivative market for currencies to develop further so that companies can better hedge themselves from currency volatility. The committee has recommended that all restrictions on ECBs be removed so that foreign loans may be availed by companies without control on end-use. This suggestion, if implemented, will compensate for the slow growth rate in domestic credit. ECBs are already emerging as an important source of funding for domestic firms, rising from $66.5 billion to $170 billion between 2009 and 2014. Share of ECBs in external debt has risen from 29 per cent to 37 per cent in this period. With further easing of restrictions, companies from a larger number of sectors will be able to tap this market. The cheaper cost of these loans will help improve profitability of Indian firms, which can tap funding institutions in the US, Europe and Japan, flush with money after the monetary easing by their respective central banks.
While there is no denying that a larger number of companies must be encouraged to borrow from foreign lenders, in lifting restrictions, the Centre needs to get the timing right. If the rupee goes into a tailspin, as it did in 2013, companies holding these loans will see their liabilities exacerbate. Such a risk is aggravated by the poor hedging ratios of domestic companies. In August 2014, only 15 per cent of these borrowings had been hedged by companies. Systemic risk will arise if many companies default on their overseas obligations at the same time. The committee’s suggestion that all companies borrowing through this route be made to hedge a certain portion of their exposure will protect against systemic risk. It will also make companies more disciplined about taking cover against forex volatility, instead of passively depending on the central bank to keep the currency stable.
However, the biggest challenge in implementing the committee’s recommendations is the under-developed currency derivative market. Excessive restrictions on participation, positions limits and margins have throttled the exchange-traded currency derivative market. Small enterprises are unable to access the inter-bank rupee forwards for hedging due to the opacity of this market. Development of an overseas market for rupee bonds can help address currency risk, but it will take time. All in all, it is best to first increase liquidity in currency derivatives and wait for the hedging ratio of companies to improve before implementing the committee’s suggestions.
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