India in a Volatile Global Economy What lies ahead? Parthapratim Pal Indian Institute of Management Calcutta

Emerging Markets are experiencing their worst capital flight….

Foreign Exchange Reserves of AEs and Developing Countries

Global Growth Rate is Slowing Down…China Rebalancing Countries/Regions EstimatesProjections World Output Advanced Economies United States Euro Area Japan Emerging Market and Developing Economies Russia China India Latin America and the Caribbean Brazil Mexico Sub-Saharan Africa

India’s recent economic developments… Growth projections by the Central Statistical Organization (CSO) for the fiscal year is 7.6 percent. This is higher than estimates by the Reserve Bank of India and the IMF. Wholesale prices fell for the 15th straight month in January 2016, with the Wholesale Price Index or WPI- based inflation declining 0.9% from that a year ago after the 0.73% fall recorded in the previous month. Inflation based on Consumer Price Index (CPI) is positive and around 5.5 percent. Mostly led by high food prices in the country. Data released this January show exports fell for the 14 th consecutive month. Current account, however, is somewhat more resilient as import bill came down due to decline in commodity prices. Corporate profitability is going down. Excess capacity on the rise in the industrial sector. Investments declining. Exchange rates are close to historical low Recent reports indicate severe stress on the banking system due to massive write-offs and Non performing assets Credit offtake from the banking system is slowing down

Devaluation of currencies among developing countries and emergence of mega trade blocks…increased vulnerability for India India’s exports have been declining for the last 14 months The current account has not been affected much because of declining import bill (due to decline in fuel prices) China is not India’s major export market but its biggest source of imports The depreciation of yuan is likely to put pressure on India. Trade deficit with China may increase Emergence of mega trade blocks like TPP is likely to affect India’s exports negatively EXPORT14, , , , , %Share IMPORT43, , , , , %Share TOTAL TRADE57, , , , , %Share TRADE BALANCE-29, , , , , India’s Trade with China (in million US $)

India is part of the global problem of growing corporate debt BIS reports estimate that the outstanding US$ denominated debt of non-banks located outside the United States is at $9.2 trillion at the end of September The corresponding figure at the beginning of 2010 was around US$ 6 trillion. The IMF Global Financial Stability report suggests that the emerging market firms that have borrowed the most are most vulnerable when debt-service costs go up as interest rates begin to rise in the developed countries. BIS asks: what motivates a non-US firm to issue US dollar bonds? Second, they try to find out what do the corporate borrowers do with the proceeds of the bond issuance? (Bruno and Shin, 2015) “The answers to our pair of questions suggest that non-financial firms from emerging market economies (EMEs) have used US dollar bond issuance to take on financial exposures that have attributes of a dollar carry trade, in addition to any use of such funds for real investment. In this respect, our results add to the evidence that favourable global financial conditions have been important determinants of firms financing decisions, especially for firms from emerging economies whose dollar bond issuance activity has been a defining feature of the post-crisis period in international capital markets”. Pp1-2

Data on India’s external debt (in million US$)

Some more information on external commercial borrowings by Indian firms Year ECB Automatic Route (US $ million) ECB Approval Route (US $ million) Weighted average of maturity in years 6-month Libor (%) Weighted Average Margin over 6-month LIBOR or reference rate for Floating Rate Loans (%) Interest rate range for Fixed Rate Loans (%)

More on Indian ECBs… To put these numbers in perspective, during the same period, benchmark Prime Lending Rate (PLR) by State Bank of India varied between percent and percent. So the effective lending rate is the PLR + spread A look at the data published by the Reserve Bank of India on ECBs show that for the period 2005 to 2015, Reliance Industries used ECBs 53 times to borrow amount equivalent to US$ 24.8 billion; Reliance Communication Ltd. and ONGC Videsh have ECBs of around US$ 8 billion. There are more than 30 Indian companies which have borrowed more than US$ one billion through ECBs between 2008 and 2015.

Some examples of use of ECBs by Indian firms Reliance Industries Ltd. Reliance Communications Ltd. JSW Steel Limited Tata Steel ONGC Videsh Ltd. Amount No. Amount No. Amount No. Amount No. Amount No. Automatic Route 5, , , , ,212 1 Approval Route 18, , , ,700 6 Total 24, , , , ,912 7

Poor Export performance and declining Hedge Ratios A look at the balance sheets of Indian firms show: The quantum of naturally unhedged ECB is three to four times the amount of borrowing that are naturally hedged. Around 50 percent of the firms undertaking ECB, which constitute over 70 percent of the ECB amount borrowed in a year, have not hedged to cover any risks arising out of foreign currency mismatches. In October 2014, indicative data with RBI showed that “the hedge ratio for ECBs/FCCBs declined sharply from about 34 per cent in FY to 24 per cent during April-August, 2014 with very low ratio of about 15 per cent in July-August 2014”. With exports declining steadily, the problem of unhedged corporate debts is likely to increase even more…

Tightening of policy rates in Advanced countries and possibility of competitive devaluation creates major problem for these companies In the eventuality of a generalized tightening of monetary policy among developed countries, there will be a double impact on the Indian corporate sector through exchange rate and global rate of interest. Monetary policy loses policy space due to possibility of reversal of capital flows? This double impact on corporate debt will be easier to handle if the corporate sector is performing well. But recent reports indicate that profitability indicators of the Indian corporate sector show worrying signs. RBI (2015) highlights that for period to , profitability of public limited companies exhibited a steady declining trend. Profitability improved marginally in the case of small and medium private limited companies. But profitability of large private limited companies declined. Recent revelations points to huge write-offs and build up of very high level of NPAs among the Indian banking system. More signs of weakness of the corporate sector.

What lies ahead…

While growth will help the system, it would likely be significantly impaired if we did not nudge the process of clean up. Non-food credit growth from public sector banks, the more stressed part of the system, grew at only 6.6% over the calendar year Industrial credit growth for PSBs was only 3.3% while growth in lending to agriculture and allied lending was only 10.4%. The only area of strength was personal loans, where growth was 16.9 %. In contrast, non-food credit growth in private sector banks was 20.2 %, in agriculture 25.4%, in industry 14.6%, and 23.5% in personal loans. Put differently, in each of these areas except personal loans, loan growth in private sector banks was at least 10 percentage points higher than public sector banks, while loan growth in personal loans was 6.6 percentage points higher.