Without cover

On the face of it, the Reserve Bank of India’s recent directive to borrowers tapping the External Commercial Borrowings (ECB) route on how they must hedge against foreign currency risks would seem to be stating the obvious. The RBI has clarified that companies must have a 100 per cent hedge against exchange risk from day one on ECBs, take cover for both coupon and principal payments and ensure that their hedges are rolled over until the loan is repaid. It also specifies that borrowers can claim a natural hedge only if the cash flows from the project materialise in the same financial year and in the same currency, as contracted borrowings. Bankers to these companies are tasked with the responsibility of monitoring that they comply with the 100 per cent hedging requirement and these other rules.

While this may smack of micromanagement, the truth is that India Inc has been quite lackadaisical about hedging the foreign currency risks in the past. With both global bond and currency markets entering a period of unusual volatility, the RBI is understandably nervous about how well-placed Indian ECB borrowers are to handle exchange rate swings. Ministry of Finance data show ECBs by India Inc making up 37.3 per cent of all external debt in India as of March 2016, with a high 28.8 per cent of the sum due within a year. Still, past estimates by the RBI suggest that only 15-30 per cent of these borrowings are hedged against currency risk. The Trump win, coming on top of the imminent Fed rate hike, has already led to a sharp spike in global bond yields setting off a bloodbath in bond markets and raising the spectre of pullouts from emerging markets such as India. Should the rupee witness unexpected volatility, these un-hedged corporate borrowers would surely be singed. With many large companies already struggling with debt repayments, any sudden bout of currency volatility can result in India’s ECB borrowers left swimming naked when the tide turns.

Any global default by Indian firms can pose a systemic risk, which the RBI’s recent moves to enforce hedging, may not fully address. Companies often complain that it is the lack of qualified advice from banks and the exceptionally high cost of hedging (4-5.5 per cent now) on the Indian Rupee that effectively deters them from taking forward cover. Therefore, building greater advisory capacity at treasury desks of Indian banks and redoubling policy initiatives for a vibrant onshore exchange-traded market in currency derivatives, are both essential to ensure that India’s ECB borrowers don’t leave exchange rate risks to chance.

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