0.2097
7667766266
x

Vulnerability due to Depreciation

iasparliament Logo
July 04, 2018

What is the issue?

  • The current rupee depreciation is likely to contribute to the vulnerability of the economy.
  • A look at the causes (policy shortfalls) and the consequences of it becomes essential.

What are the recent developments?

  • Foreign investors are exiting from India’s financial markets.
  • This is triggered by the end of quantitative easing in the US and Europe.
  • It is particularly by the hikes in policy interest rates in the US, making investments attractive.
  • This has resulted in a sharp depreciation of the rupee relative to the dollar.

What led to this?

  • Crisis - The US and Europe infused liquidity after the 2008 financial crisis.
  • Credit at near zero interest rates was available to banks and financial agents.
  • This was to lend or invest at low rates to record profits.
  • Thereby it facilitated resolving their balance sheet hit by the crisis.
  • It flooded markets with large volumes of cheap money in the process.
  • Carry trade - Under this, banks, financial institutions and investors borrowed cheap in the dollar market.
  • But they invested in assets denominated in other currencies for higher returns.
  • The rush of funds shored up these currencies and even resulted in appreciation.
  • India was a country that benefited from flows of this kind.
  • India’s corporate sector utilised the cheap credit from foreign financial firms.
  • Impact - This has resulted in a high proportion of outstanding foreign bank claims.
  • India is now paying the price for this legacy of debt.
  • Clearly, depreciation raises the rupee costs of imports.
  • It also increases the rupee equivalent of payments made to service foreign debt.

How has the bond market been?

  • The channels through which credit has been flowing into the country has changed.
  • Clearly, the share of bank loans and deposits has come down from 2013 to 2017.
  • While, the share of debt securities has increased in the same period.
  • The corporate bond market which was inactive for long had turned active in recent years.
  • Financial institutions in the carry trade, experimented with corporate bonds.
  • This suited Indian corporates as bond issues are likely to have less intensive scrutiny.
  • However, exit is much easier for bond investors.
  • They can choose to book profits or cut losses and leave.
  • But this results in stress on the balance of payments and the rupee.

What are the policy shortfalls?

  • The current vulnerability could have been prevented by policy decisions.
  • The corporates should have not been encouraged to exploit that supply-side push.
  • But, the ceilings on external commercial borrowing have been relaxed hugely over the liberalisation years.
  • Foreign investors have been given easy access to the country’s debt markets.

How do these make India vulnerable?

  • The debt exposure allowed by the above has now created two kinds of vulnerabilities.
  • Firstly, it can lead to rupee depreciation when investors choose to exit.
  • This intensifies any depreciation resulting from other factors.
  • Secondly, depreciation increases the rupee costs of servicing foreign debt.
  • It can lead to losses and push firms to default on both domestic and foreign debt.
  • Vulnerability that legacy debt creates arises from the volume of exposure.
  • But besides, it also arises from its likely concentration in a few firms.
  • How - Firm reputation influences access to foreign credit markets and institutions.
  • It is thus likely that foreign debt would be concentrated in a small number of firms.
  • This factor carries the enhanced debt-servicing burden for these few companies due to rupee depreciation.

 

Source: BusinessLine

Login or Register to Post Comments
There are no reviews yet. Be the first one to review.

ARCHIVES

MONTH/YEARWISE ARCHIVES

sidetext
Free UPSC Interview Guidance Programme
sidetext