The untold risks from RBI’s rule relaxations for foreign currency loans

The logo of Reserve Bank of India (RBI).  (Reuters)

In these troubled times, the Reserve Bank of India’s (RBI’s) decision to relax rules on the end use of external commercial borrowings (ECBs) looks like the much-needed solace, especially if you were a defaulting company running from pillar to post to get some funds for survival.

The intent is clear. When domestic lenders are loathe to give money due to the toxic pile of debt they already have, sophisticated foreign peers who are better placed to price risk would be willing to lend a hand. After all, the economy is in dire need of funds to wake up the animal spirits of private investment. The timing is also right as dollar liquidity is plentiful and investors are scouting for higher yield.

But there are many untold risks to the RBI’s friendly leeway on ECBs. In particular, the permission to use foreign currency loans to pay back rupee loans is a concern. “It does look that the risks are high in allowing stressed companies to borrow from offshore markets. I am not sure how safe it would be for all the end-use restrictions to be removed,” said Abheek Barua, chief economist and executive vice president at HDFC Bank Ltd.

Barua said the spread of risk to offshore lenders would morph into another risk of exchange rate for the borrowing companies in the future.

Indian companies are not able to repay back loans for a host of reasons, including the slowdown in the economy, an uncertain policy environment and even global headwinds. In many cases, defaulters have intentionally refrained from paying back lenders. In short, balance sheets are weak and still highly leveraged.

In allowing the use of foreign currency proceeds to pay back rupee loans, there is simply a transfer of risk to the offshore lender. “The credit risk is being exported or rather spread to offshore balance sheets. There could be temporary relief, but a weak balance sheet won’t be able to finance a new forex loan. This is needless risk taking,” said an economist on condition of anonymity.

But, perhaps, it may not come to that at all. The condition of having a weighted average tenure of 10 years for an external commercial loan defeats the purpose of the freedom to raise money, say analysts. As the adjoining chart indicates, weighted average tenures of forex loans was a little over five years in May and has been five-six years. To raise long-term foreign currency funding, the borrower will have to pay a premium. The ceiling of 450 basis points above the benchmark rate chosen, typically the London Interbank Offered Rate, prevents the borrower from giving higher return. Therefore, attracting dollars would be difficult.

In sum, while RBI may have intended to help Indian firms get funding more easily, the central bank may have inadvertently encouraged riskier borrowing even with weak balance sheets.

[“source=livemint”]