Why IMF warnings on corporate debt binge in emerging markets should be taken seriously


In emerging markets (EM), corporate debt binge, especially in foreign currency, makes firms vulnerable to shocks at a time of volatile capital markets and weak economic growth, warns a new paper from the International Monetary Fund (IMF). Indian companies are no exception, having used lower global interest rates, following the financial crisis, to borrow more in overseas markets even as their debt-servicing ability fell.

At the end of June, India’s commercial borrowings had risen to 38.4% of the country’s external debt—almost double where they were 10 years ago.

The commercial borrowings referred to here include both foreign currency borrowings and portfolio investments in Indian corporate debt paper.

At the same time, the median gross interest cover ratio of the country’s top 500 borrowers (in terms of balance-sheet debt) has fallen to 1.49 times compared to 2.69 times in fiscal 2009.

The IMF’s latest edition of the Global Financial Stability Report (analytical chapters) warns of increased stress as the accommodative global financial conditions are reversed, even as there is trouble brewing in China. It is only a matter of time before the US Federal Reserve hikes interest rates, which could prompt an outflow of capital from both equity and bond markets and also strengthen the dollar.

According to India Ratings and Research Pvt. Ltd, about 45% of overall corporate debt is in the books of firms, which will be negatively affected if the rupee falls against the dollar.

The IMF’s financial stability report added that the most leveraged companies would also have to endure the sharpest increase in their debt service costs as interest rates begin to head north.

While money raised through bonds tend to have longer maturities than bank finance, firms would have to deal with financial market volatility.

What’s more, “the adverse impact on debt-service ability is accentuated where corporates borrow more in foreign currency but have low natural hedges,” says the IMF paper Stress testing Corporate Balance Sheets in Emerging Economies by Julian Chow.

There is another warning here for Indian firms. As the M.S. Sahoo report on external commercial borrowings released earlier this year found out, nearly 80% of such loans are taken by firms which have no natural hedges. When a company’s net exports for a year is less than 20% of its annual repayment of ECB for the year, it is said to have no natural hedge.

Secondly, although there has been an improvement from 15% levels, the hedging ratio (mainly financial hedges) of Indian firms is only about 40% of their foreign currency exposure, says Reserve Bank of India (RBI).

Such low levels of hedges could be one reason why RBI is allowing rupee-denominated overseas bonds. But all they will do is eliminate exchange rate risk.



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