Widening CAD to increase borrowing costs, bring down volume of fresh forex loans: India Ratings report

Mumbai: The widening current account deficit (CAD), which is projected to cross 2.6 percent of GDP this year, coupled with the rupee plunge, is likely to increase borrowing costs for corporates and bring down the overall volume of fresh forex loans, says a report.

By losing over 9 percent year-to-date, the rupee is the worst performing among major emerging markets currencies. The currency plumbed a new closing low yesterday at 70.15 against the American dollar.

The rising CAD and crude prices and the falling rupee have spiked the June quarter CAD to 1.9 percent against 0.9 percent in the year-ago period, and the same is projected to scale 2.6 percent by March.

"A widening CAD, weakening rupee, coupled with rising interest rates, and forward premium can impinge on the ability of corporates to tap foreign markets to raise debt capital. For instance, annualised forward premium on the three-months rupee-dollar futures contract rose to 4.36 percent on 21 August from 3.46 percent on 31 March, 2018, reflecting a commensurate rise in hedging costs," India Ratings noted in a report on Tuesday.

Similarly, higher capital outflows and widening CAD will increase the credit spreads, it warned.

Representational image. News18.

Representational image. News18.

The widening CAD is accompanied by an increase in capital outflows ($5.5 billion so far in FY19) primarily from debt capital markets, it said, adding this can further worsen the demand-supply mismatch in debt markets, thereby widening credit spreads over the near to medium term.

It can be noted that higher CAD not only results in a hardening of benchmark yields--the 10-year Gsecs yields, but also puts upward pressure on companies' credit spreads, which will cull their liquidity, further reducing their financial flexibility.

The report warned that the pains for the rupee are not over yet as it sees externalities resulting in turbulence in EM currency markets are likely to result in more volatility of the rupee over the near term.

"A sharp rise in yield volatility typically increases investors' exposure to interest rate risks and therefore increases the uncertainty risk premium," it said.

Over the last 16 months, not only have corporate yield curves have been shifting upwards, but also the curvature of the yield curve itself has transformed, primarily driven by a higher increase in short- and intermediate-term yields than in short-term and long-term yields.

"We believe that this shift will raise borrowing costs for corporates and financial institutions looking to mobilise capital for intermediate tenures to fund capex requirements," the agency said.

Noting a strong correlation between the effective cost of funds and CAD, the report said the challenges in mobilising risk capital are likely to intensify for corporates in case fiscal challenges like weakening balance of payments (BoP) situation continue for a longer period.

A moderation in BoP typically translates into a substantial rise in the effective cost of funds for the top 500 corporate borrowers by debt and is accompanied by a consequent moderation in the median interest coverage ratio.

Despite a significant weakening of the rupee, merchandise exports have remained subdued and even contracted in the last two months. GST-led disruptions in input credit lock-up last year dampened MSME exports.


Updated Date: Aug 28, 2018 17:55 PM

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