External Debt

External debt refer to the Long-term Loans availed by Indian entities, including the government, from non-resident lenders.

India generally lacks enough credit in general for the growth of the industry.

1. This is particularly true for even the Corporate sector.
2. Even the government pays a high level of interest on its Sovereign bonds compared to the developed countries.

This makes it essential for the External borrowings to pick up. Despite this, India’s external debt to GDP ratio is only around 18.7% (by 2023). This is poor even by the international standards. By December 2023, it stood at around $648.2bn.

Challenges Faced in External Borrowing

1. Exchange Rate Risk: Fluctuations in the value of the Indian Rupee against foreign currencies impact the cost of repayment for external loans. In other words, by the time when the foreign investors encash their investment, the value of the Rupee is much lower. This means that foreign investors lose money due to the exchange rate.
2. Interest Rate Risk: Changes in global interest rates can affect borrowing costs. Rising rates may increase the cost of existing and new loans.
3. Regulatory Framework: Compliance with regulations set by the Reserve Bank of India (RBI) and other authorities can be complex and may deter some entities from seeking external financing.
4. Geopolitical Factors: Political and economic instability in both India and borrowing countries can impact the willingness of foreign lenders to provide funds.
5. Market Volatility: Global economic instability and market volatility can affect investor sentiment, making it harder to secure external funding.
6. Debt Sustainability: High levels of external debt can raise concerns about debt sustainability, leading to a cautious approach from lenders and investors.
7. Documentation and Legal Issues: The documentation process for external borrowing can be lengthy and complicated, often leading to delays and increased costs.
8. Creditworthiness and Ratings: The creditworthiness of borrowers is assessed through ratings, which can impact the terms and availability of external borrowing. Poor ratings may lead to higher costs or restricted access.

The problem of Credit Rating:

• Mismatch at present: The typical credit rating of PPP projects being implemented through SPVs is BBB Bonds, whereas regulatory agencies (IRDA) mandate a rating of at least ‘AA’ for investment by long-term pension and insurance funds. This makes the market spread of Infra bonds difficult.
• In 2017, a new seven-point credit rating scale for infra projects based on the expected loss methodology was introduced to help channel long-term funding to infrastructure projects.
• The IRDA has accepted EL 1 (lowest expected loss) the plus A rating.

Steps Taken to Improve External Credit:

1. RBI eases norms for external commercial borrowing (ECB):
   1. List of eligible borrowers expanded: All entities eligible to receive FDI can now borrow under the ECB framework under an automatic route. Port trusts, SEZ units, SIDBI, EXIM bank, registered entities engaged in microfinance activities, registered societies/trusts/cooperatives and NGOs.
   2. The extant framework for Rupee-dominated bonds and ECB is rationalized to further improve the ease of doing business.
   3. Long-term: RBI has decided to keep the minimum average maturity period at 3 years for all ECBs.
   4. They can be assessed under two routes: automatic and approval.
2. Uridashi Masala bonds: rupee-denominated instruments sold only to offshore investors by Indian corporates for raising money from overseas investors.
   • They do not face currency fluctuation risks.
   • Corporations mainly use it as an alternative to ECBs that are to be raised and repaid in dollars or other currency terms. However dollar-dominated ECBs face currency risk due to fluctuations in exchange rates.
3. Green bonds: They are aimed at energy efficiency, pollution prevention, sustainable agriculture, fishery and forestry, the protection of aquatic and terrestrial ecosystems, clean transportation, sustainable water management, and the cultivation of environmentally friendly technologies.
   • They are created to encourage the sustainability and development of brownfield sites.
   • Aug 2015: IFC became the first entity to issue a Green Masala bond on the London Stock Exchange.
4. Credit Enhancement Fund: It will be set up as an NBFC with ₹500Cr fund to facilitate infrastructure investment by insurance and pension funds; It’ll thus help enhance credit ratings of bonds issued by infra companies.

Funding:

1. IIFCL (India Infrastructure Finance Company) is the lead sponsor and financial institutions and PSBs as shareholders.
2. AIIB will take a 10% equity stake in a ₹500-crore credit enhancement fund that seeks to raise investments in operational and stabilised infrastructure projects.

Problems in external borrowings:

1. Currency Fluctuations & Exchange Rate Risks: Depreciation of the Indian Rupee (INR) increases repayment burdens for loans denominated in foreign currencies. Global factors such as US Federal Reserve rate hikes impact exchange rates, leading to higher interest payments.
2. High Cost of Borrowing: Interest rates on external commercial borrowings (ECBs) are often higher than domestic loans due to country risk premiums. Sovereign credit ratings (e.g., Fitch, Moody’s, S&P) affect borrowing costs, making it expensive during economic slowdowns.
3. Debt Sustainability Concerns: Rising external debt-to-GDP ratio increases debt repayment risks. Short-term foreign borrowings can create liquidity crises, as seen in the 1991 balance of payments crisis.
4. Global Economic Conditions: External borrowings depend on global liquidity and interest rate cycles. Economic crises like COVID-19 and the 2008 financial crisis made access to external funds difficult.
5. Dependence on Foreign Capital: Excessive reliance on foreign debt increases external vulnerability. For example, FDI and remittances are more sustainable compared to high-interest external loans.
6. Regulatory Restrictions & Compliance: SEBI and RBI impose strict rules on ECBs, including sectoral limits and end-use restrictions. Foreign lenders demand higher guarantees from Indian firms, reducing borrowing flexibility.

Instrument specific Problems

1. Negative list: Real Estate activities, investment in Capital Market, equity investment and repayment of rupee loans except from foreign equity holders.
2. RBI had capped funds raised via ECBs at 6.5% of GDP, at current market prices, based on GDP figures for Mar 31, 2018, ‘the soft limit works out to $160bn‘.

Addressing these challenges requires strong forex reserves, better debt management, and boosting domestic capital markets to reduce excessive reliance on external borrowings.

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