A depreciating rupee poses risk to external commercial borrowing (ECB), a favoured route to raise money, as the cost of borrowing goes up. However, it may be good news for domestic lenders. Whether banks can cast off their bad loan baggage and rise to the task is a different matter.

Raising money via the ECB route has emerged as a favourite mechanism among companies. Relatively lower interest rates and easing of ECB norms by the Reserve Bank of India made them an attractive fundraising option.

In the first three months of fiscal year 2019, total ECB registrations have seen decent rise compared to the corresponding months of last year, according to the Reserve Bank of India data.

However, the recent sharp depreciation in the Indian currency could play spoilsport. In this year so far, the rupee has dipped nearly 10% and is currently trading at 70.15 against the dollar.

As the rupee weakens, it pushes the cost of hedging higher, thus reducing the benefit from borrowing from an overseas market.

According to Anil Gupta, vice-president, sector head-financial sector ratings, Icra Ltd, the 3-month forward annualized hedging premium has increased from 3.97% in April 2018 to 4.09% in May to 4.34% in June and 4.48% in July 2018. “Because of the depreciating rupee, hedging costs have been going up during last few months, which apart from a general increase in international interest rates will increase the borrowing costs for Indian companies. So, the rupee-denominated ECBs or Masala bond issuance may take a hit in the near-term, since currency risks on these bonds is borne by investors," he said. A falling rupee will prompt companies to opt for other channels to meet their cash requirements.

The traditional way of raising funds for Indian companies has been from banks, which has been under pressure due to rising bad loans. Corporate bonds and commercial papers are some other alternatives to garner funds.

Madan Sabnavis, chief economist, Care Ratings Ltd, expects India Inc. to move back to banks. “Bank credit has already become attractive as these rates are more sticky compared with, say, the market where bond yields have risen with alacrity when the RBI raises rates. Banks may be the preferred route today as transmission of rate hikes is sluggish," he said.

However, Gupta is of the view that given the weak capital position of public sector lenders, the banking system may not be able to support high credit demand and, commercial paper being a short-term source of fund, has its own limitations in the overall borrowing mix of a company. “As per RBI data, as on July, commercial paper volumes surged 96% on a year-on-year basis. This sharp increase in volume is not sustainable and, hence, we expect some part of the commercial paper borrowings to shift to bonds, which shall result in higher bond issuance during second half of FY2019," said Gupta.

In short, while ECBs may lose some steam in the short-term, the weakening rupee and rising interest rates could boost demand in domestic sources of funds.

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