Fresh worries on corporate growth
Weakening rupee, widening current account deficit threaten credit access to India Inc
The Indian rupee continued to lose ground against the US dollar last week. The weakening rupee and the widening current account deficit (CAD) threaten access to credit for India Inc, raising questions over the revival in capex cycle.
Exports lose steam
In the normal course of events, a weaker rupee should provide a fillip to Indian export volumes. However, the situation in Q1FY19 has been very different. Export growth continues to remain modest. On the import front, rise in prices of crude oil and other commodities, coupled with a depreciating rupee, has resulted in a burgeoning import bill. For instance, monthly CAD expanded to around $18 billion in July 2018. At this pace, CAD is poised to touch 2.6 per cent of GDP in FY19.
While on the one hand, domestic exporters are hoping to gain traction out of the weak currency and improving global economies, on the other hand, headwinds in the form of challenges in accessing working-capital credit, rising trade protectionism, slow improvement in productivity levels and simultaneous rising of input costs are likely to dampen prospects of exports growth in the current fiscal. For instance, the gross deployment of export credit shrunk by 42 per cent in June 2018 alone. With limited access to working capital, exporters are likely to face challenges in scaling up their operations in order to capitalise on the opportunities arising out of a depreciating rupee.
FPI outflow hits hard
A widening CAD typically results in a rise in interest rates (especially market-based rates). However, in the current scenario, the increase in interest rates worldwide, coupled with rejuvenated demand for risk capital in developed economies, has resulted in a peculiar situation. Since Q3FY18, Foreign Portfolio Investor (FPI) investments have been contracting, with net outflows of over $7.50 billion in Q1FY19 alone.
The outflow of FPI investments has further worsened the liquidity situation in the domestic markets, while further increasing the volatility in both the currency and bond markets. This affects Indian corporates at two levels. First, volatility in the currency markets increases the cost of hedging for importers and Indian borrowers. Consequently, the annualised premium on the three-month USDINR future contract increased to 4.36 per cent in August 2018 from 3.46 per cent in March 2018 — reflecting a commensurate 90 bps increase in hedging costs for corporates.
This, in effect, will impinge the ability of Indian corporates to borrow from external markets. Sectors such as power, and oil and gas could, therefore, see long-term borrowings become more expensive, while working-capital financing and day-to-day hedging costs for sectors such as pharmaceuticals and textile could increase over the near-to-medium term. This comes especially at a time when the Indian banking sector is facing challenges in extending necessary financial assistance to Indian corporates. For instance, upcoming renewable power projects could face higher input costs on the back of rupee depreciation.
Second, volatility in the bond market results in an increase in risk premium, especially for medium-to-long-term instruments (five years and above). On the other hand, yields on short-term instruments (1-3 years’ maturity) are driven by the current liquidity condition and expectation from monetary policy. Consequently, corporate spreads widen and the increase in cost of borrowing for corporates surpasses the rise in benchmark yields. With the lending ability of various public sector banks constrained, this is in turn likely to constrain the ability of corporates to mobilise capital to fund their capex plans, thereby further delaying the recovery of the corporate capex cycle.
At an aggregate level, commodity importers are, for instance, likely to face higher input costs and a rise in working-capital requirements — both financed at higher interest rates.
Non-banking finance companies (NBFCs), on the other hand, have demonstrated a significant role in the financial system, especially in the past few years. With the liberalisation and advancement of the financial system, the interest rate sensitivity, too, has increased. Weakening liquidity and a rise in intermediate term yields are likely to exert pressure on NBFCs to increase their reliance on short-term instruments. For instance, commercial paper issuances touched an all-time high of nearly ₹4.90 trillion in Q1FY19. Such a situation increases the asset-liability management risks for NBFCs by increasing their vulnerability to market disruptions. In an environment wherein the lending ability of the banks is constrained, an increase in funding costs for NBFCs is likely to further put pressure on the borrowing costs and financial flexibility of Indian corporates.
On the other hand, FPI outflows from debt markets and rising corporate credit spreads are likely to further stymie the corporates’ access to domestic markets. Rise in hedging costs will limit their access to external borrowings as well.
The writers are Analyst and Associate Director, respectively, at India Ratings & Research, a Fitch Group Company.