The globalization of Indian companies has often been commented on. However, few bother to pay much attention to a parallel trend—the globalization of their finances. Indian companies now have more dollar assets and liabilities in their books than ever before, thanks to overseas acquisitions and borrowing. What are the implications of this?
The World Bank’s new Global Development Finance report that was released on 29 May offers us some clues in a chapter on the globalization of corporate finance in developing countries. The World Bank says that companies from the developing world raised $156 billion through global equity and bond issues in 2006; syndicated loans were worth $245 billion; and cross-border M&A deals were valued at $100 billion. Since 2002, companies from countries such as India and China have raised more than a trillion dollars from the international financial markets. That’s an eye-popping number.
The biggest advantage of this lending spree is that it takes some pressure off domestic banks and financial markets. As the big boys borrow abroad, the smaller guys have more local savings coming their way. This allows domestic savings to be redirected to areas such as small businesses and rural development. The World Bank says that other activities are not “crowded out” because of the large borrowing needs of the corporate sector. In simpler terms, this suggests that domestic interest rates would have been far higher in countries such as India if their largest companies had borrowed locally rather than globally. That seems a sensible enough conclusion to us.
But this advantage comes with a few attendant risks, both to corporate balance sheets and national economies. We see these risks in India, though they tend to get ignored amid the noisy celebration of record economic growth. The torrential flow of foreign money into India is partly because of a global credit boom that has mispriced risk and pushed credit spreads to record lows. The flood of liquidity has pushed down interest rates and made borrowing attractive. The recent asset boom has also improved the credit worthiness of many firms, as rising asset prices have raised the value of collateral on offer.
But booms can turn into busts. Capital can quickly change direction and head for the exits. That’s when the ability of companies and central banks to manage risks will really be tested. It is easy to scoff at the concerns expressed by the Reserve Bank of India (RBI) on the problems posed by large capital flows into the country. But, almost exactly 10 years after a financial crisis kayoed many Asian economies, RBI’s approach does not look too cautious to us. It is true that India has more than $200 billion of foreign exchange reserves and it has taken on little short-term debt. Yet, financial panics can break down even the strongest of defences.
The other set of challenges is faced by companies that have borrowed abroad. A lot depends on what use the money is being put to. Some of it has been used to buy global assets, thus building a natural hedge in the balance sheet—dollar revenues will pay off dollar liabilities. But a lot of the money has been used to fund domestic expansion; and quite a bit has found its way into volatile sectors such as real estate. Indian companies are by no stretch of the imagination taking the sorts of risks that companies in places such as South Korea, Thailand and Indonesia took in the run-up to the Asian financial crisis of 1997. But, as legendary investor Warren Buffett famously said: “It is only when the tide goes out that you know who has been swimming naked.” The tide of foreign capital flooding in looks comforting—but both RBI and companies would do well to swim with their trunks on.
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