BIS warns on offshore debt of non-banking firms
International banking activity steadily expanded during April and June with cross-border claims increasing by 1.2% in the year to end-June 2014
Geneva: Indian residents had outstanding cross-border claims of more than $204 billion at the end of June, according to the Bank for International Settlements (BIS).
China, however, continues to be the largest borrower among emerging market economies with $1.1 trillion, followed by Brazil, India and South Korea at the end of the first half of 2014.
International banking activity steadily expanded during April and June with cross-border claims increasing by 1.2% in the year to end-June 2014, the first move into positive territory since late 2011. China’s borrowings have doubled since end-2012 increasing from $524 billion to $1.1 trillion in the first half of this year. Chinese nationals have borrowed more than $360 billion through international debt securities, from bank and non-bank sources.
“Contrary to prevailing wisdom, any vulnerabilities in China could have significant effects abroad, also through purely financial channels," says Claudio Borio, head of the monetary and economic department at BIS, an organization for central banks all over the world which is located in Basel, Switzerland.
India’s borrowings increased to $204 billlion at the end of September from $201.5 billion at the end of the previous quarter.
Non-financial firms in India and China are increasingly resorting to issuing debt securities through their offshore companies. “[The] Indian and Chinese non-financial firms [are] issuing [debt securities] mainly through non-financial subsidiaries," according to BIS.
Yet there are no concrete estimates of the quantum of funds raised by offshore affiliates of Indian non-financial companies. “We don’t know exactly the quantum of funds raised by Indian companies but we know the issue," says a banker familiar with the BIS quarterly review for December 2014.
The Reserve Bank of India (RBI) on 25 November clamped down on Indian firms raising funds overseas and routing them to India through certain types of structures. In a notification, RBI noted that some Indian firms access overseas markets for debt funds through overseas subsidiaries and associates and later route those funds back to their Indian operations.
One of the ways this has been done is through investment in rupee bonds floated by the Indian company.
RBI clarified that Indian companies are not allowed to “issue any direct or indirect guarantee or create any contingent liability or offer any security in any form for such borrowings by their overseas holding/associate/subsidiary/group companies except for the purposes explicitly permitted in the relevant regulations."
RBI further added that funds raised by an overseas subsidiary, associate or group company cannot be used in India unless it conforms to the general or specific permissions granted under the Foreign Exchange Management Act (FEMA) regulations.
RBI also stated that those Indian firms or their investment banks which are using or establishing structures that contravene these norms, shall be liable for penal action.
The BIS review contains an article written by three BIS economists—Stefan Avdjiev, Michael Chui, and Hyun Shin—which chronicles the increased external borrowing through issuance of debt securities by offshore affiliates of companies based in China and India. Though the views of these three economists do not represent those of the BIS, they point toward a wider source of financial instability in emerging market economies.
“Between 2009 and 2013, emerging market non-bank private corporations issued US $554 billion of international debt securities," of which the Chinese affiliates have borrowed $252 billion, the article says. These funds raised through debt securities are transferred back to the parent company either to finance a local (headquarters) or loaned to another company or bank. “If the overseas bond proceeds are repatriated onshore to invest in domestic projects with little foreign currency revenue, the firm will face currency risk," the BIS economists caution.
Instead of using the monies raised offshore for investment projects abroad, the Indian and Chinese companies are deploying the funds for different domestic investment/financial transactions with (potential) adverse consequences, the economists suggest.
The review also revealed some puzzling trends about banks’ cross-border claims on emerging market economies that have risen sharply since the “taper tantrum" in mid-2013 when the US Fed had decided to gradually reduce purchasing assets. Despite the buoyant market conditions over the last several months, there is a growing “fragility" in the global financial scene with small pieces of developments here and there capable of causing massive instability across the world. “To my mind," says Borio, “these events [since October 15] underline the fragility—dare I say growing fragility?—hidden beneath the markets’ buoyancy."
He says “small pieces of news can generate outsize effects"—which in turn can amplify mood swings. The turbulence in the markets is largely contained due to “soothing statements" from major central banks suggesting that they might delay normalization in light of evolving macroeconomic conditions. “Recent events, if anything, have highlighted once more the degree to which markets are relying on central banks: the markets’ buoyancy hinges on central banks’ every word and deed," Borio said.
Significantly, the “abnormal" conditions are becoming “uncomfortably normal"—with the central banks pushing benchmark sovereign yields to extraordinary lows which were unimaginable just a few years back, the BIS official has argued. “Three-year government bond yields are well below zero in Germany, around zero in Japan and below 1% in the US," Borio told reporters last Friday.
Two major developments—exchange rate movements and the sharp drop in oil prices—stemming from the recent period need to be closely monitored. Given the divergent macroeconomic conditions and differing monetary policies adopted by the European Central Bank and the Bank of Japan (which have loosened policy) and the US Federal Reserve which has stopped purchasing assets while hinting at an interest rate hike at some point in 2015, there have been sizeable exchange rate shifts.
The sharp drop in oil prices by 40% since June this year could “disproportionately affect some regions of the world, possibly compounding domestic vulnerabilities."
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