External commercial borrowings by the corporate sector in India

• DOI: http://doi.org/10.1002/pa.1987
• Date: 01 February 2020
• Author: Gourishankar S. Hiremath,Ashis Kumar Pradhan
• Published date: 01 February 2020

PRACTITIONER PAPER

External commercial borrowings by the corporate sector

in India

Ashis Kumar Pradhan

1

|Gourishankar S. Hiremath

2

1

Department of Economics and Finance,

Rajagiri Business School, Kochi, India

2

Department of Humanities and Social

Sciences, Indian Institute of Technology

Kharagpur, Kharagpur, India

Correspondence

Ashis Kumar Pradhan, Department of

Economics and Finance, Rajagiri Business

School, Rajagiri Valley Campus, Kakkanad,

Kochi‐682039, India.

Email: ashiskumarprdhn@gmail.com

The growing levels of external commercial borrowings (ECBs) among the emerging

and developing economies have raised the fears that ECBs would lead to widespread

crisis and threaten financial stability in India. Against this backdrop, the current study

seeks to examine the trends and critically evaluate the policy pertaining to ECBs. In

order to immune the economy from potential exchange rate shocks, we suggest to

having specific policy focus on the domestic bond market, hedging mechanisms,

and appropriate decisions on the cap and level of ECBs by the regulator.

1|INTRODUCTION

The emerging and developing economies (EDEs) have been witnessing

a new surge of corporate borrowings in foreign currency in recent

years.

1

In line with the global trends, the number of companies relying

on external finance in India is increasing as the constraints on such

borrowing were relaxed. The cheaper access to credit is expected to

lower the cost of capital, supplement domestic saving, and capital for-

mation in the underdeveloped economies and eventually contribute

economic growth. However, the corporate debt in foreign currency,

in the event of external shocks, increases the cost of debt repayments,

reduces the profits, and adversely affects the investment and net

worth of the indebted firms.

A couple of financial crises as those of the Mexican peso crisis and

the Asian currency crisis have challenged the conventional theories,

which consider that crises were due to the interplay of macroeco-

nomic factors. The first‐generation

2

and second‐generation

3

models

of crisis failed to explain the crises convincingly. The third‐generation

models introduced two new inputs: the influence of balance sheets on

investment of the firms and the effect of capital flows on the real

exchange rate. As a result, the emphasis has been shifted from macro-

economic to microlevel variables. These models hold debt

denominated in foreign currency as primary protagonists of the finan-

cial crises in the past. The experience in East Asia and a couple of Latin

American countries shows that the interaction of firm‐level variables

with the macro economic variables such as exchange rate exposes

the economy to widespread crisis.

4

Krugman (1998) also acknowl-

edges the private corporate sector profligacy as the primary cause of

the East Asian crisis.

Therefore, policy discussion on external commercial borrowings

(ECBs)

5

in India has always been controversial. One view is that

increasing ECBs leave domestic companies vulnerable to external

shocks. In such instances, the firm‐level financial panic turns into a

macroeconomic crisis and leads to financial instability (e.g., Chui,

Fender, & Vladyslav, 2014; Ghosh & Chandrasekhar, 2009). On the

other, Sahoo (2015) committee recommends easement of restrictions

6

on ECBs to provide corporate sector a valid option to borrow in for-

eign currency and spur the investment and growth. In light of this the-

oretical and policy debate, the current research seeks to explore the

1

In the aftermath of Latin American debt crisis in 1970–1980, several EDEs reintroduced the

controls on debt flows and others were reluctant to open the economy for such flows. Such

restrictions were relatively stringent for private entities. Nonetheless, a new wave of debt

flows is seen in emerging economies especially in BRICS. This surge in borrowings in foreign

currency can also be a reason of “Original Sin”—weaknesses in financial markets prevent firms

in EDEs to borrow from abroad in domestic currency or raise long‐term debt domestically

(Eichengreen & Hausmann, 1999).

2

In first‐generation models, the rational investors flee the currency when they anticipate gov-

ernment's inability to defend the pegged exchange rate system due to growing deficits (see,

Krugman, 1979).

3

The investors doubt the ability of the government to maintain fixed exchange rate system

without fundamentals being weak, and investors flee. The government may increase the inter-

est rate to retain the investors, but it hurts the growth. The investors' expectation of an attack

by others on the currency leads to self‐fulfilling prophecies ending the pegged system

(Obstfeld, 1994, 1996).

4

In particular, the Latin American debt crisis left these countries in parch and many economies

imposed controls on capital flows especially the debt creating flows.

5

External commercial borrowings are long‐term debt raised by the Indian companies from

global market in foreign currencies. We use ECBs, foreign currency borrowings (FCBs), corpo-

rate borrowing, and dollar debt interchangeably.

6

Following the recommendation, RBI relaxed the norms further in 2015 for Indian corporate

to raise funds through ECB channel.

Received: 29 April 2019 Accepted: 9 May 2019

DOI: 10.1002/pa.1987

J Public Affairs. 2020;20:e1987.

https://doi.org/10.1002/pa.1987

© 2019 John Wiley & Sons, Ltd.wileyonlinelibrary.com/journal/pa 1of6