The Reserve Bank of India (RBI) Financial Stability Report found that 44% of private sector external commercial borrowing (ECB) is unhedged against currency fluctuations.
Over the past two years, the corporate sector has taken advantage of ultra-low interest rates globally to replace high-cost domestic liabilities and has also borrowed funds for expansion, etc. Many refrained from hedging as it increased the cost of funds.
This high level of uncovered loans is alarming as the Rupee has depreciated against the US Dollar.
In the first six months of the calendar year 2022, the rupee has already depreciated by almost 6% against the US dollar. The rupee lost 4% of its value against the US dollar in the 2021-22 financial year.
The outlook for the Rupee is not very optimistic due to the global fallout from historically high inflation and also higher interest rates. In fact, the US Fed also decided to reduce the size of its balance sheet by $8.5 trillion in the post-global financial crisis. Tighter liquidity and rising interest rates will further weaken the value of the rupee.
According to RBI data, the total amount of ECBs in circulation is $1,79,994 million.
According to the RBI report, “Almost 80% of the ECB is denominated in US dollars, with the remaining 5% being denominated in euros and Japanese yen.”
The unhedged share of BCE amounts to 79,125 million dollars, or 44%.
The RBI report also adds that there is a natural hedge in some cases of unhedged loans, where the borrower’s earnings are also in foreign currencies, for example, shipping lines. But the central bank gave no percentage or number of cases where there is natural hedging.
In January this year, an RBI working paper on the “optimal hedging ratio” had pegged the hedged share of foreign currency lending at 63%. Currently, the hedged share is well below 56% of total foreign currency lending.
The RBI working paper had also noted that hedging all FX exposures in full might not be optimal in the sense that with fully hedged FX exposure, the benefit of low cost access to foreign capital is lost.
“This study reveals that the optimal hedge ratio, whether financial or natural hedge at the system level, can be around 63%, although the strategy in practice may vary over time, a a little higher ratio could be useful in times of expected stress,” the working document states.
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