The Reserve Bank of India(RBI) painted a very worrying picture of India's external debt scenario in a report released late last week. The total external debt of the country stood at $ 390 billion as on March 31,2013. This was an increase of $44.6 billion or 12.9 percent in comparison to March 31, 2012.
Even on a quarterly basis the increase is substantial. As on December 31, 2012, the total external debt had stood at $376.3 billion. This implies an increase of 3.6% of the three month period between December, 2012 and March, 2013.
The external debt typically consists of external commercial borrowings (ECBs) raised by companies, NRI deposits, loans raised from the IMF and other countries, short term trade credit etc. What is worrying here is that nearly 44.2% or $172.4 billion of the outstanding external debt matures on or before March 31, 2014.
The borrower will have to sell rupees and buy dollars in order to repay this maturing foreign debt. When this happens, it might lead to a surfeit of rupees and a shortage of dollars in the foreign exchange market, leading to a further fall in value of the rupee against the dollar.
The foreign investors pulled out investments worth more than Rs 44,000 crore from the Indian debt and equity markets during the month of June, 2013. During the process of conversion of these rupees into $7.53 billion, the demand for dollars went up, and pushed the value of one dollar beyond sixty rupees. The rupee has since recovered a little, and as I write this one dollar is worth around Rs 59.24.
The broader point is that if the demand for $7.53 billion can cause a massacre of the Indian rupee against the dollar, $172.4 billion of debt which needs to be repaid before March 31, 2014, can create a bigger havoc.
The ratio of debt that needs to be paid before March 31, 2014, to the foreign exchange reserves of India is around 59%. This was at 17% as on March 31, 2008. This is another number that tells us very clearly the precarious position India is in as far as its external debt is concerned.
One factor that needs to be considered here is that all the maturing debt may not need to be repaid. Take the case of NRI deposits. As on March 31, 2013, they stood at around $70.8 billion, having gone up nearly 20.8% since March 31, 2012. NRIs typically invest in India because the interest that they earn on deposits is higher in comparison to what they would earn by investing in the countries that they live in. Interest rates offered on bank deposits continue to remain high in India in comparison to the western countries. So does that mean that NRIs will renew their deposits and not take their money out of India?
Interest is not the only thing NRIs need to consider while investing money in India. They also need to take currency risk into account. With the rupee depreciating against the dollar, the 'perception' of currency risk has gone up. Lets understand this through an example.
An NRI invests $10,000 in India. At the point he gets money into India $1 is worth Rs 55. So $10,000 when converted into rupees, amounts to Rs 5.5 lakh. This money lets assume is invested at an interest rate of 10%. A year later Rs 5.5 lakh has grown to Rs 6.05 lakh (Rs 5.5 lakh + 10% interest on Rs 5.5 lakh). The NRI now has to repatriate this money back. At this point of time lets say $1 is worth Rs 60. So when the NRI converts rupees into dollars he gets $10,080 or more or less the same amount of money that he had invested.
Given this, NRIs are more likely to repatriate their maturing deposits, rather than renew them, and this will put pressure on the rupee dollar exchange rate. Data from the RBI suggests that NRI deposits worth nearly $49 billion mature on or before March 31, 2014.
External commercial borrowings worth $21 billion need to be repaid before March 31, 2014. Companies can pay off these loans by raising fresh loans. But in the aftermath of the Federal Reserve of United States, the American central bank, deciding to “taper” or go slow on the money printing, fresh loans may not be so easy to come by. Also, businesses may want to pay up as quickly as possible given that more the rupee depreciates against the dollar, the greater is the amount in rupees they would need to buy dollars needed to repay there loans.
Interestingly, nearly $43.3 billion of external commercial borrowings are set to mature between April 1, 2014 and March 31, 2016. So to cut a long story shot, much of the external debt maturing before March 31, 2014 will have to repaid and this will put further pressure on the rupee vis a vis the dollar.
India's burgeoning external debt is only a recent phenomenon. As on March 31, 2007, the total external debt had stood at $169.7 billion. Since then it has jumped by a massive 129.8% to $390 billion. There are basically two reasons for the same.
The first reason is the burgeoning fiscal deficit of the Congress led United Progressive Alliance(UPA) government.
Fiscal deficit is the difference between what a government earns and what it spends. For 2007-2008(i.e. the period between April 1, 2007 and March 31, 2008), the fiscal deficit had stood at Rs 1,26,912 crore. For the year 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014) it is projected to be at Rs 5,42,599 crore or nearly 327.5% higher.
The higher fiscal deficit has been financed through greater borrowings made by the government. In order to borrow money the government had to offer better terms than available elsewhere, and thus managed to push up interest rates. This encouraged NRIs to invest their money in India. NRI deposits have increased from $41.24 billion as on March 31, 2007, to $70.82 billion as on March 31, 2013.
Higher interest rates also led to businesses looking at cheaper options abroad. External commercial borrowings went up from $41.44 billion as on March 31, 2007 to $120.89 billion as on March 31, 2013. Interest rates were lower abroad primarily because the Western central banks had unleashed a huge money printing effort in the aftermath of the financial crisis that started in late 2008 to get their respective economies up and running again. And this is the second reason behind India's burgeoning foreign debt.
To conclude, tough times lie ahead for the rupee. The recent Financial Stability Report released by the RBI points out that “rise in India’s overall external debt is an added source of concern.” But that is a very mild “British” sort of way of putting it. What we need here is a classic American expression. When it comes to the rupee “you ain't seen nothin' yet”.
(Vivek Kaul is a writer. He tweets @kaul_vivek)