India’s weak external position has manifested itself in the volatility of the Rupee, which was one of the worst performers amongst Asian currencies in 2011. Indian businesses, which have unhedged foreign currency borrowings, have incurred significant losses as the value of their debt rises as the Rupee falls.
The problems are compounded by the fact that Indian companies face large debt maturities in the coming year. The ability to refinance the debt coming due remains an issue in an environment of a weakening economy as well weaker company outlook.
European banks have reduced their lending in Asia, choosing to focus on home markets in Europe. In an interesting development, Reliance Communications was forced to turn to Chinese banks for finance. The transaction was conditional on the purchase of equipment from China.
Refinancing issues are also complicated by the fact that the some of the debt is in the form of foreign currency convertible bonds (“FCB”s) designed to convert into the issuer’s shares rather than be repaid at maturity. Indian companies have over $5 billion of convertible bonds maturing in the current year.
In an environment of booming stock markets between 2005 and 2008, FCBs provided companies with low cost debt. However, the toxic combination of falls in share prices and a fall in the value of the Rupee (in which the shares are denominated) means that the FCBs will not convert and need to be repaid. The repayment in foreign currency will crystallise large currency losses. In addition, refinancing the FCBs will result in much higher borrowing costs, which will significantly affect the profitability of Indian corporations.
The refinancing issue poses a problem for the RBI. India has US$250-300 billion in currency reserves (enough for around 7 months of imports). Foreign debts that must be repaid in the current year are around 40-45% of this amount, which if deducted highlights the increasing weakness in India’s external position.
In an effort to manage the problems, India has eased the regulations on foreign lending to India hoping to attract investment.
Slowing growth, tighter credit and other economic problems have increased corporate defaults to the highest level in 10 years resulting in bad loans. Non performing loans are now around 2.5-3.00% of bank assets. Analysts estimate that the major banks have around $25 billion in bad loans, an amount which is increasing.
The problem is greatest for government owned banks, which constitute 75% of the banking system. The bad loans are concentrated in sectors such as power, aviation, infrastructure, real estate and telecommunications.
The common element is that these industries are characterised by government involvement and which have suffered from erratic government policy or wholesale interference. In electricity, state owned utilities have accumulated losses of $14 billion, in part because low government mandated rates dictated by political considerations do not cover the cost of generation.
Two of India’s biggest airlines, the State owned Air India and the privately held Kingfisher Airline, are now struggling to pay employees as they struggle under large debt burdens.
The Indian government has already moved to recapitalise State owned banks to ensure their capital position. In the process, the budget deficit and the government borrowing requirements have come under increasing pressure.
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