Look before borrowing

RBI Deputy Governor Subir Gokarn has indicated the RBI will ensure companies have adequate foreign exchange liquidity for any need. Several companies have exposure to the European banking system for short-term trade credit needs as well as longer-term borrowing. The current difficulties in European banks suggest they are likely to de-leverage,or lend less.

The terms for borrowing in dollars were very attractive for many years. On the one hand,interest rates in international markets have been very low,while high and rising in India. However,since these were dollar loans,the stability of the rupee was a major factor in determining the attractiveness of the loan. Many companies borrowed abroad. But the sudden turmoil in the Indian rupee-dollar market and the weakening of the rupee meant bets companies had placed on a low-interest burden on their debt turned out to be one on which they made big losses. There is little the RBI can do to ensure companies have rupees to pay back. Where the RBI has a role is to make sure that if there is a sudden need for dollars,it will step into the forex market and ensure an adequate supply of dollars by selling reserves. After the 2008 Lehman crisis,there was a similar situation when dollar liquidity dried up. Considering that trade credit is essential for smooth exports and imports,the RBI stepped in and provided dollar liquidity by selling over 18 billion of reserves. A similar situation may arise soon. What the RBI cannot do is try to prevent rupee depreciation in a persistent and sustained manner. Selling reserves for liquidity purposes will be a useful and necessary step in case there is a sudden tightening of liquidity.

In the medium run,it is important that companies assess the risks they are undertaking by borrowing in dollars more realistically than they have. With revenues in rupees and liabilities in dollars,they would be taking on currency exposure which they should hedge to become resilient to currency fluctuations. Indian companies and markets today are not sophisticated enough to provide adequate hedges. The government recently raised the ceiling on how much could be borrowed abroad. This is not a wise thing to do now as it could increase currency risk for firms.