It seems a long time ago but it was around this time last year that economists were debating the need for capital controls; foreign funds couldn?t get enough of Indian stocks, with the result that September alone saw more than $7 billion flowing in. In October, RBI expressed its anxiety at the surge in capital flows, hinting that it might intervene if flows were volatile or lumpy. By the end of the year, FII investments would be nudging $30 billion, throwing open a debate on whether India needed to impose a Tobin tax. The high current account deficit, at around 3.7% of GDP, put paid to the issue, but rising interest rate differentials and strong domestic growth buoyed debt-creating inflows, which had rebounded to 4.3% of GDP by June 2010. The result was a steadily appreciating rupee, which moved to 44 against the greenback, with the consensus betting it would hit 43 before December and sure that sooner or later RBI would step in to bail out the country?s exporters. A large part of corporate India believed that the rupee would remain strong and as a result left some part of their foreign exchange borrowings unhedged.
A recent study by Kotak Securities shows that Indian companies face an estimated $24 billion of redemptions of external commercial borrowings (ECBs) or foreign currency convertible bonds (FCCBs) in FY2012-13. As such, if companies have left any portion of their loans unhedged, they could be badly hit. As for FCCBs, the bonds may not get converted into equity because the price of the stock may be way lower than the conversion price. FCCBs worth roughly $7 billion will come up for redemption over the next two years for S&P CNX 500 companies. Analysts reckon that of these, FCCBs worth R220-240 billion, translating into nearly 80% of the total outstanding FCCBs, may not get converted into equity shares.
Should these need to be refinanced, the interest burden on companies will be higher, given that FCCBs attract very low coupon rates, some of them structured at 0%. If, on the other hand, borrowers negotiate a lower conversion price, the company?s equity base would get further diluted. As if this wasn?t bad enough, many firms haven?t provided for a repayment in their books, assuming the FCCBs would get converted. A study by Kotak shows that for a sample of 166 companies, the average finance cost was 7.2% in FY2011. This, the brokerage points out, seems low and is perhaps pulled down by the low cost of overseas borrowings and other benefits. Moreover, the average cost is even lower for companies with overseas borrowings. Also, in a trend that doesn?t reflect the best accounting practices, many companies take the impact of forex-related movements, in foreign currency loans, in the balance sheet.
Indeed, the sharp fall in the rupee could hit corporate India badly. If it turns out that the low cost of borrowings is the result of companies not having hedged themselves sufficiently and were betting on a stable exchange rate, their calculations could go horribly wrong. Tech firms would, by and large, be gainers; in fact, since most of them meticulously hedge their exposures, they would miss out notionally. But even where companies have a natural hedge in the form of exports, they could get hurt if they have borrowed large amounts in foreign exchange and left the exposure uncovered. For instance, analysts point out that Ranbaxy and Jubilant have high forex debt, making them most likely to report large translational losses and higher interest costs. Again, state-owned oil marketing companies (OMCs) point out that the depreciation of the rupee results in higher under-recovery because the higher cost of buying crude is not always passed on to the customer. While there has been a drop in crude oil prices, under-recoveries are nonetheless expected to go up; for every rupee of weakness, the subsidy burden rises by about R9,500 crore. That apart, these OMCs also have dollar-denominated debt on their books, though most of it is hedged. At another level, foreign institutional investors have seen the value of their portfolios being eroded and would be understandably cautious. Perhaps some intervention by the central bank may have helped. However, RBI so far is believed to have stepped in only on limited occasions. There are those like Samiran Chakraborty of Standard Chartered Bank, who believe that rising imported inflation and volatility risks support the case for greater intervention. But it?s possible the central bank is wary of the fallout such a move may have on liquidity, at a time when growth is slowing down.
shobhana.subramanian@expressindia.com