India Economy

Why Urjit Patel is anxious about Fed tightening

Lokeshwarri SK | Updated on June 17, 2018

Urjit Patel, RBI Governor   -  REUTERS

Signs of stress are visible in the external debt data of the India’s private sector

A day before the June monetary policy meeting, RBI Governor Urjit Patel sprung a surprise by writing a column in The Financial Times, asking the US Federal Reserve to go slow with its balance sheet-shrinking programme.

Why did Patel pen the article? Is India’s external debt situation getting difficult? We looked for some answers in the Centre’s external debt report.

Data show that overseas finance, especially that of Indian companies, is getting difficult to access. Some of the external debt ratios are also not in the comfort zone.

FT piece

Patel stated in the FT article that the Fed had dealt a double whammy on global markets by — one, commencing its balance sheet reduction in October 2017, and two, bloating its deficit sharply through the tax cuts announced by the Trump regime.

Patel argued that with the fiscal deficit of the US expected to increase to $804 billion in 2018 and $981 billion in 2019 as a result of the tax cuts, the US government borrowings can crowd out other borrowers, making liquidity conditions tight, at a time when the Fed was also on the road to reducing its balance sheet size.

“Given the rapid rise in the size of the US deficit, the Fed must respond by slowing plans to shrink its balance sheet,” wrote Patel. “If it does not, treasuries will absorb such a large share of dollar liquidity that a crisis in the rest of dollar bond market is inevitable.”

Justified fears

The RBI Governor also pointed out that signs of tightness were already visible in global markets.

A look at India’s external debt numbers reveals that his concerns are not misplaced.

India’s external debt stood at $513.4 billion towards the end of December 2017.

This was 8.8 per cent higher than the debt towards the end of March 2017. The worrying part is that the debt taken by non-government entities account for $404 billion, amounting to 78.8 per cent of the total debt, with government debt accounting for the remaining share

Also, the private sector’s debt is growing at a faster pace, and amounted to 16.1 per cent of GDP towards the end of December 2017, up from 15.8 per cent share in 2012.

The government’s external debt, on the other hand, has declined from 4.8 per cent of GDP in 2012 to 3.9 per cent in 2017.

There is also a perceptible slow-down in trade financing in the overseas market in recent times.

Buyer’s credit outstanding has steadily declined from $8,767 million in December 2015 to $6,795 million towards the end of December 2017.

Similarly, outstanding loans taken from overseas commercial banks have declined from $99,025 million in 2015 to $84,616 million in 2017; overseas borrowings by banks have also reduced from $16,514 million to $14,453 million in the same period.

ECB (External Commercial Borrowings) and FCCB (Foreign Currency Convertible Bonds) issuances of corporates have however grown at a good clip, increasing from outstanding loans of $15,000 million in December 2015 to $27,042 million in December 2017.

Corporates might have found overseas interest rates more competitive than domestic ones, but this could prove to be a double-edged sword in the current scenario, where global bond yields are moving higher. This will make it more expensive to re-finance or roll-over these loans. With borrowing costs in the domestic market also moving higher, Indian companies could face challenging times ahead.

Deteriorating ratios

Some of the external debt ratios of India are also not too comforting. The cover provided by the foreign exchange reserves to external debt is currently 79.7 per cent. While the RBI has been buying dollars to protect the country from global risk-off trades, it appears that this is not sufficient. This ratio was at a healthier 138 per cent in 2007-08 and 106 per cent in 2009-10.

Our capability to get concessional debt from multilateral organisations, too, seems to be weakening over the years. While these subsidised loans accounted for 45.9 per cent of the total debt in 1990-91, this share is currently down to 8.6 per cent, translating into higher interest outgo for borrowers.

The ratio of short-term debt to total debt has also been gradually moving higher over the years, from lower single digits prior to 2004, to 19 per cent now.

It’s clear that Patel is justified in worrying about the Indian private sector’s external borrowings. But with most global central banks embarking on rate hikes and monetary tightening, it is apparent that these conditions could become the norm going ahead.

What now?

Since not much can be done about overseas markets, the RBI needs to instead focus on the ongoing efforts to clean the banking system and deepen the bond markets so that Indian corporates do not starve for want of financing.

Published on June 17, 2018

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