Mint Explainer: Does India have a dire external debt situation?

Should India take care of its external debt? Can India see a Sri Lanka-like meltdown in the near future? How well placed is it to meet all of its short-term external debt repayment obligations without burning a big hole in foreign exchange reserves and a run on the rupee? A debate over India’s external debt repayment schedule has sparked a confrontation between the Trinamool Congress (TMC) and leaders of the Bharatiya Janata Party (BJP).

On June 10, TMC MP Jawhar Sircar tweeted that India could be headed for a “Sri Lanka-style debt trap” and presented RBI data to back up his claim. Here is what Sircar seemed to suggest, just as in the case of Sri Lanka, a weakening currency would increase India’s debts, leading to ratings downgrades and ultimately economic collapse. BJP spokespersons , Sanju Verma and Amit Malviya, hit back with their own analysis to prove that the opposition was alarmist. So what is the reality?

What do political parties bicker over?

Sircar pointed out that 43% of India’s external debt, or more than $267 billion, must be repaid over the next nine months, saying this would significantly deplete our foreign exchange reserves and weaken the rupee. Verma pointed out that India’s external debt was only 21% of GDP. while that of Sri Lanka was over 63%. She said India had a mountain of foreign exchange reserves [about $588 billion] to meet foreign debt obligations. Malviya added that less than 3% of this debt is from the central government. Speaking exclusively to Mint, the Chief Economic Adviser (CEA) of the Government of India, V. Anantha Nageswaran, explained: “Most of the external debt consists of trade finance, which is normally rolled over, and some loans long-term. The extent of the repayment obligation has been in the range of 35-45% in the past. Only if in any case the lender refuses to renew and insists on repayment, can this become a problem, which is very unlikely.”

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For now, it looks like India’s external debt is manageable and unlikely to trigger an economic upheaval.

What was the reality on the ground?

Nageswaran, no doubt, makes sense. Repayments of India’s short-term external debt (with a residual maturity of one year) have been largely constant over the years, as the CEA points out. Many companies and businesses seek to refinance their debt, including loans, to support their operations, as long as their debt management is fundamentally sound. Much of the short-term debt has been easily replaceable on the global credit market given the influx of liquidity by central banks at interest rates at the lowest in recent years, first after the crisis financial world, then after the pandemic. In fact, in the United States, benchmark interest rates had been below 1% for years before the Fed started raising rates recently. Japan even had negative interest rates to stimulate demand. This clearly does not make debt repayment a priority for businesses. And, of course, the Reserve Bank of India is watching India’s external debt levels very closely to keep it from spiraling out of control. The maximum amount of external commercial debt that a company can raise is $500 million.

What can be different now?

This year, more businesses may want to swap their dollar-denominated loans, which account for more than 50% of Indian loans, for rupee-denominated loans for two reasons. First, global interest rates are rising, and second, the rupee is losing value quite rapidly. It has already depreciated by more than 6% this year. Together, this can make domestic rupee loans more attractive. Consider a very simple calculation of interest rates on dollar loans: 1.5% to 1.75% (US benchmark rate) plus a 6% decline in the value of the rupee against the dollar , or about 8%. And the Fed plans to keep raising rates. In India, the external benchmark lending rate (EBLR) for banks ranges from 7.4% to 8.6%. Thus, some experts believe that companies might want to swap their external debt for domestic debt to reduce their exposure to global macroeconomic uncertainties. This could be another way to reduce currency risk to protect margins. Granted, many companies hedge their forex exposure with derivatives, but taking a call on the rupee comes with its fair share of risk in these turbulent times.

What about imminent foreign debt repayments?

External debt levels alone do not seem to worry the central bank, for the moment. In fact, in a recent article, the RBI argued that India could potentially add another $90 billion to its external debt, taking it from 20% of GDP to 23%. The central bank and the government would keep their fingers crossed and hope that most companies would be able to refinance their debt as usual. There may be a short-term impact on the rupee, particularly if corporate repayments are larger than expected in an uncertain global macro environment. This could add to the weakness of the Rupee and possibly also make it more volatile in the short term. But, for now, it looks like India’s external debt is manageable and unlikely to trigger an economic upheaval.

Do you know India’s growing public debt is a concern? mint explains what this means for the economy.

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