After four consecutive years of heavy foreign currency borrowings, Indian companies appear to have reined in their desire to borrow overseas owing to some increase in volatility in the currency, lower domestic interest rates and the limited need for long-term capital.
Until September this year, Indian companies had borrowed just under $20 billion from the overseas markets through loans and bonds. This is about a third lower than the amount borrowed in each of the last four years respectively. Overseas borrowings had hit a high in 2011 when Indian companies borrowed $36 billion in foreign currencies. Since then, every year, borrowings have stayed above the $30-billion mark, until this year.
To be sure, there are still a couple of months left before the year ends but the pipeline of borrowings appears to be thin so it is quite possible that foreign currency borrowings this year will end up being the lowest since 2009.
In an interview to Bloomberg news this week, Reserve Bank of India (RBI) governor Raghuram Rajan noted that external commercial borrowings (ECBs) have come down significantly this year: “...maybe people are now less convinced that borrowing in dollars is a one way bet," Rajan told Bloomberg.
That is certainly one reason.
While the Indian currency has been relatively stable (compared to other emerging market currencies) this year, there has been some increase in volatility. Also, the RBI has been consistently communicating to the markets that it will not defend any particular levels on the rupee in the face of adjustments in the global currency markets. That, together with the possibility of sharp movements in the dollar in reaction to global monetary policy decisions, has put some fear in the minds of Indian companies and forced them to hedge more. Banks, too, have been pushing clients to hedge more actively following a diktat from the regulator.
As soon as you start hedging foreign currency borrowings, the cost advantage compared to domestic borrowings reduces, making the former less attractive.
Another reason for the reduced interest in foreign currency borrowings is that interest rates in the domestic bond markets have also dropped following a 125-basis point cut in interest rates announced by the central bank in 2015. (One basis point is one-hundredth of a percentage point.)
While banks have not cut rates quickly, rates for market borrowings have adjusted allowing for lower cost borrowings. There has also been some deepening of the corporate bond market with mutual funds investing more actively in corporate debt at least until recently. A delay in bond repayment by one large company (Amtek Auto Ltd) has roiled the market and the impact of that in terms of change in regulation governing mutual fund investments in corporate bonds is still to fully play out.
A third factor worth noting while considering the lower borrowings this year is the limited capital expenditure being undertaken by large Indian conglomerates. For instance, Reliance Industries Ltd, which has been an active borrower in the overseas markets in the past couple of years, is now nearing the end of its capital expenditure cycle. Telecom operators like Bharti Airtel Ltd have also been pushing up capital expenditure ahead of the launch of fourth generation (4G) services and some of this has been financed through overseas borrowings.
The next set of chunky borrowings may only come once the broader investment cycle picks up. In the interim, opportunistic refinancing will continue.
The focus will now also shift to rupee-denominated borrowings through so-called Masala bonds. Now that the guidelines and the tax treatment for such bonds have been detailed, a handful of companies are already preparing for such issuances, although they are likely only next year.
On 26 October, Mint reported that India Infrastructure Finance Co. Ltd (IIFCL), Indian Railway Finance Corp. Ltd (IRFC) and NTPC Ltd are among the companies laying the groundwork to issue rupee-denominated bonds. Housing Development Finance Corp. Ltd (HDFC) has also taken board approval for a rupee bond issue.
Given this interest in the new instrument, it is possible that we will see some shift in overseas borrowings away from foreign currency borrowings and towards rupee-denominated borrowings. If that happens, it is a welcome development because it helps reduce the currency risk associated with foreign borrowings while still allowing Indian borrowers to access the wider pool of international investors.
There is some scepticism, though, on how quickly this market will develop. In a note issued on Wednesday, rating agency Fitch Ratings noted that while the ability to issue bonds offshore in rupees gives companies the opportunity to diversify funding sources, the market may initially be limited to only a few. “The ability to diversify funding would be credit positive, but in the early stages of development, the market will likely be restricted to better-quality issuers or ones with some degree of name recognition in the local markets," said Fitch. It added that investment grade state-owned enterprises and large non-bank financial institutions will probably be the handful of companies that will be in a position to use this instrument. “Smaller, sub-investment-grade issuers may not find the Masala bond market practical. Notably, foreign-investor interest has yet to be tested, and will be affected by sentiment regarding the rupee/US dollar exchange rate and other macro factors," said Fitch.
Ira Dugal is assistant managing editor, Mint.