The Fed is not a problem, unhedged foreign debt is
The US Federal Reserve’s tightening monetary policy or its raising of interest rates, expected sometime in June this year, was supposed to result in outflows of foreign flows from emerging markets, including India, as investors moved money back to the US. The Fed’s relatively dovish statement on Wednesday—it has indicated it would be ‘patient’ while raising rates—however, suggests that rate increases might begin only in the second half of the year. While that is a relief, the issue is whether, when US rates go up, this will prompt foreign funds to pull out money from India. Unlike at the time of the ‘taper talk’ in mid-2013—when investors withdrew money from the Indian bond markets, causing the rupee to start depreciating—this time around, foreign flows have not just stayed put, more is coming in. In January, close to $3 billion has come into the bond market, much of it into corporate paper, and another $2 billion has been invested in the equity market.
According to CRISIL, India is the strongest among emerging economies given the stable political environment and the significantly improved external situation. That apart, as the rating agency points out, the sharply narrowing CAD—which is tracking at half the levels of 2012—easing inflation and expectations that the economy could return to a 6%-plus growth in FY16 have combined to form a strong pull-factor for capital flows. With foreign exchange reserves as a record high of $322 billion and the rupee stable at levels of 61-61.50 to the dollar, the situation is indeed comfortable.
However, while all may be well from a country perspective, corporates that have foreign exchange exposures, should not be sanguine about their liabilities. While it is unclear whether Jaiprakash Power has fully hedged its forex bonds worth $200 million, if it has not, a weaker rupee has meant the company will now need to pay back a much larger sum; the company said on Wednesday it might renege on its commitment to repay the dues by mid-February and would consult with bond-holders. Indeed, anxious that a very high quantum of corporate foreign borrowings, the bulk of which remains unhedged, RBI has for some time been cautioning corporates they not depend on it to bail them out in the event the currency depreciates sharply. The central bank has gone so far as to ask banks to make additional provisions for any unhedged exposures their corporate customers may have. Indeed, even if the outlook on the currency appears rosy right now, banks need to be vigilant.