Allowing poorly rated firms access is premature
Just about two years ago, when the talk of the US taper began, just selling of $6-7 billion of Indian paper by FIIs was enough to send the rupee into a downward spiral. The rupee has, of course, regained much of the lost ground but at 62.5 to the dollar today—the all-time low was 68.8 to the dollar—it is still considerably weaker than the 55-levels it was in May 2013. The depreciation has been so sharp that any company that had locked itself into a large dollar exposure, without a matching hedge, would have suffered severe damage to its financials. In fact, the dollar has strengthened significantly over the last few months on the back of expectations of an interest rate hike in the US by the Federal Reserve in the near future. This is why the government would do well to accept the Sahoo panel’s recommendation to make it mandatory for all companies to hedge their foreign exchange exposures. If not the full amount, a significant part of the exposure needs to be hedged. RBI has been worried about this for a while—it estimates that as much as three-fourths of all exposures could be unhedged—and has been asking banks to ensure that client exposures are adequately hedged. However, given there are enough companies that will not fall in line unless compelled to do so by law, and since the risks are too high to ignore—about 37% of the total forex debt is accounted for by corporate debt—the government must put in place the necessary rules.
Given the plethora of restrictions on end-use of funds got from ECBs, it is not surprising that the Sahoo panel has plumped in favour of easing restrictions in most sectors, except those where FDI is banned. While removing restrictions is a good idea, some caution is also required at the same time. India’s reserves are at an all-time high in absolute terms—they are close to $341 billion right now—but in terms of import cover, they have been higher in the past. Also, while the current account deficit is under control right now, it had gone up to 6.5% of GDP in the December 2012 quarter—given the shallow nature of the forex market, a combination of high CAD and poor reserves is what makes the rupee vulnerable to even a small withdrawal of funds. In such a situation, for the next few years, it may be prudent to lift ECB restrictions only for companies and banks that are financially strong and capable of repaying their borrowings to access markets overseas, via loans or bonds, regardless of the sector they belong to. Overseas bond defaults by companies with weak financials is not a risk worth taking.