Asia | Credit | Emerging Markets | FX
The domestic credit crunch in India has extended. This is forcing Indian borrowers to increasingly rely on USD borrowing.
India’s credit crisis started in September 2018 when ILFS, an infrastructure company, defaulted on a money market instrument. The crisis is ongoing and continues to dominate the outlook for Indian credit and financial markets. Specifically:
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The domestic credit crunch in India has extended. This is forcing Indian borrowers to increasingly rely on USD borrowing.
India’s credit crisis started in September 2018 when ILFS, an infrastructure company, defaulted on a money market instrument. The crisis is ongoing and continues to dominate the outlook for Indian credit and financial markets. Specifically:
• It has been a year since the initial shock dried up wholesale funding for Non-Bank Financial Companies (NBFCs) but they are still largely shut out from public capital markets. Funds raised by NBFCs through domestic bond issuance fell to INR 8.8bn in June, barely one-tenth the size of what they issued in January.
• NBFCs with strong parentage and vintage are able to plug that financing hole by borrowing from banks. But this is crowding out bank lending to other sectors. Banks’ exposure to NBFCs has risen 40% YoY, while credit growth to all other sectors has fallen to under 7% (chart 1).
• NBFCs without strong backing from banks and with heavy exposure to non-performing assets appear increasingly vulnerable to disorderly unwinds.
• Banks are opting for safer assets in capital markets too – their holding of commercial paper is down 38% YoY in favour of sovereign bonds. Even though the RBI has cut policy rate by 135bps and eased liquidity policy, corporate bond spreads for AAA borrowers have tightened only by 30-50bps from peak levels amid much weaker net supply.
• While Indian authorities are aware of the credit crunch, a proactive approach towards isolating and unwinding bad debts has been missing. The RBI has insisted that the financial system is capable of discriminating, even though this month it was forced to intervene in a regional bank experiencing a run. The central bank has eased monetary policy aggressively and the government has cut corporate taxes. These are helpful, but transmission could come with long lags. As such, tight funding conditions for the sector will probably persist for some time.
• The real economy sector most exposed to this funding squeeze is real estate development. Credit flow to developers has been weak for about a year due to the funding issues at NBFCs. The slowing economy could dampen homebuyer demand further, thereby compounding the cash flow issues of developers.
• As the domestic credit machine sputters, NBFCs and corporates have turned to offshore borrowing. On a rolling 12-month basis, External Commercial Borrowing – the principal channel for this – has increased USD46bn, up 55% YoY.
What does this mean for the rupee? We can make the following inferences:
1. The slowdown in credit growth has led to a collapse in imports. Trade deficit has improved, and the current account deficit is on course to print under USD10bn for Q3. This is broadly in line with FDI. Belt tightening, while never pretty, is part of the adjustment process. The basic balance of payments (CA+FDI) has been a solid guide for medium-term movement in the rupee, and the trajectory is consistent with a stable rupee.
2. Even as collapse of imports has moved external flows into equilibrium, the rapid increase in external borrowing is deteriorating India’s external balance sheet. Luckily, there is a cushion: even though net IIP deteriorated to -USD450bn from -USD400bn a year ago, this is still about 15% of GDP compared with 30% for Indonesia. RBI’s FX reserve adequacy ratio has fallen to 139% from 159%, but this is still within comfortable range. In short, it is too soon to worry about India’s external liquidity.
3. The heavy reliance on external credit financing makes INR vulnerable to an exogenous shock for US$ funding or global investor confidence in EM credit. Fortunately, with the Fed returning to Balance Sheet expansion mode, concerns about US$ funding may be diminished. Moreover, hard currency credit funds continue to see net inflows.
Net-net, I expect the core trading range of 70/72 to persist in USDINR for the rest of this year. The range is porous to the topside. If global credit conditions deteriorate significantly, INR would be acutely vulnerable. However, if Indian authorities alter their approach and manage to intervene more effectively in ring-fencing troubled NBFCs, this may boost investor confidence and lead to a modest appreciation of INR.
Indian Bank & Non-Bank Credit Growth
Indian Non-Oil Trade Dynamics
Source: Reuters
Mirza Baig is a macro strategist, specialising in Asian FX and fixed income markets. Mirza is currently working as a desk analyst at Morgan Stanley, prior to which he worked in macro strategy roles at BNP Paribas and Deutsche Bank
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