Too much, too soon will spell trouble for India overseas debt
A panel set up by India’s Ministry of Finance to review the rules for companies borrowing money from overseas has made the radical suggestion of doing away with the current system and immediately liberalising the regime. Such an approach is likely to be too much of a shock to the country’s financial system. The government would be wise to adopt a more gradual approach.
India has some of the most onerous rules for companies wanting to raise debt offshore. Against that backdrop, it made sense for the government to set up a committee to look into the system and provide recommendations.
It certainly didn’t pull its punches, saying that the existing framework was too restrictive and had outlived its usefulness. The panel went even further, saying the current system should be scrapped, including the controls on how much debt companies can raise, and at what price. Instead, it recommended a much more liberal regime, with the proviso that companies hedge a portion of their foreign currency exposure in order to contain systemic risks.
The panel is to be applauded for taking such a forthright approach to the problem and for being willing to counteract the current orthodoxy in India, which favours too much regulation rather than too little.
There certainly needs to be some liberalisation. But it would be wrong for the government and the Reserve Bank of India to adopt the panel’s advice and do away with all the controls. A more measured approach is called for.
A current account deficit economy like India cannot afford to reverse policy and remove caps on external debt in the rapid manner pushed by the committee. It needs shock absorbers.
The country is currently benefiting from the commodity price fall, but a turn in the commodities cycle and the likelihood of a US interest rate rise later this year could change its fortunes. Then there is the prospect of the goods and services tax, due to be rolled out next year, which is expected to lead to a spike in inflation.
The panel has tried to provide a safeguard by making it a requirement for companies to hedge their risk, but this is unlikely to be embraced widely. If it became mandatory to hedge a portion of the risk, firms with lower or no dollar revenues would much rather curb their offshore borrowing than bear the increased cost of hedging.
It's worth remembering that the Indian banking system was relatively unscathed by the global financial crisis in 2008, thanks to the regulatory measures of the country’s central bank. Although the rupee suffered as a result of the drastic change in external environment, the RBI’s prudence ensured much less damage was done than otherwise might have been.
And there was also the taper tantrum of summer 2013: India was one of the main victims, with the rupee and the country's stock markets going into free fall and borrowers shut out of the international markets for nearly two months.
There are also plenty of other factors that need to fall in place before India can give its companies free rein to borrow overseas.
Most importantly, there is a need to deepen local currency capital markets, which remain illiquid and hard to access. Better capital markets would allow companies to become more familiar with market-driven pricing for borrowing — and would also make it easier for corporates to hedge their risk.
This was indeed mentioned in the panel's report, which pointed out that many jurisdictions comparable to India in size and governance offer borrowers a more favourable environment when it comes to hedging exposures. Brazil, for example, has well-developed exchange-traded and over the counter derivatives markets.
There are already some signs that the central bank and the Indian government are taking steps to accelerate the development of domestic markets. RBI governor Raghuram Rajan recently expressed his intent to allow Indian companies to raise external debt through the issuance of rupee bonds in overseas centres.
However, these measures will take some time to take effect and it would be better for the government to concentrate on strengthening its domestic markets before liberalising external debt rules in a big way.
This is not to say that the panel’s recommendations are untenable. It would be a game-changer for both India and the global economy if the country were to loosen the reins. Fortune may often favour the brave, but in this case it would pay for India to be cautious.