In the past few years, since the 2008 global financial crisis, India's external sector has become increasingly vulnerable. The plunge taken by the Indian rupee recently is an effect of this perception of an increase in vulnerability.
About External Debt
External debt is the portion of its debt borrowed from foreign institutions. India's external debt has seen a stark rise in the last six years. According to data by the Reserve Bank of India, India's external debt stood at $390 billion as of March 2013, up 12.9% from $344.6 billion seen in March 2012. This amounts to 21.2% of the Gross Domestic Product (GDP) - used to measure growth.
This composes of various bonds (like FCCBs) and borrowing (like ECBs). An inability to pay off its external debt may spark a crisis. So far, India has been financing its debt by a surplus in foreign fund inflows. In the event of an unavailability of such capital flows, the country then turns to its foreign exchange reserves to finance its debt repayment.
Why has it shot up?
A number of reasons have contributed to this rise. According to an assessment by the Reserve Bank of India, the increase in the total external debt in 2012-13 was primarily due to a rise in short-term trade credit. This means businesses are borrowing overseas due to near-zero interest rates prevailing in those markets. In India, interest rates are far too high. Besides this, many non-resident Indians are buying short-term Indian deposits to take advantage of interest rate differential in India and outside India. The widening of trade deficit - the net difference in imports and exports - on account of a higher import bill has also caused a rise in external debt. A depreciation in rupee has made debt costlier as it must be paid back in the same currency it was loaned in.
Impact
A rise in external debt - especially short-term debt - increases a country's vulnerability to capital inflows. This is even more risky now as the US Federal Reserve has indicated a withdrawal of its bond-buying program, which had led to influx of foreign funds into emerging markets like India. Foreign investors have thus moved their funds out of emerging markets, thus resulting in a net outflow of funds. Financing would be a challenge in India. This will in turn put pressure on its forex reserves, which are now at its lowest levels since 1997.
At a time when the rupee has depreciated to its all-time low against the dollar, the RBI needs sufficient forex reserves to stem the free-fall. A rise in debt, thus, puts pressure on the rupee too.
About External Debt
External debt is the portion of its debt borrowed from foreign institutions. India's external debt has seen a stark rise in the last six years. According to data by the Reserve Bank of India, India's external debt stood at $390 billion as of March 2013, up 12.9% from $344.6 billion seen in March 2012. This amounts to 21.2% of the Gross Domestic Product (GDP) - used to measure growth.
This composes of various bonds (like FCCBs) and borrowing (like ECBs). An inability to pay off its external debt may spark a crisis. So far, India has been financing its debt by a surplus in foreign fund inflows. In the event of an unavailability of such capital flows, the country then turns to its foreign exchange reserves to finance its debt repayment.
Why has it shot up?
A number of reasons have contributed to this rise. According to an assessment by the Reserve Bank of India, the increase in the total external debt in 2012-13 was primarily due to a rise in short-term trade credit. This means businesses are borrowing overseas due to near-zero interest rates prevailing in those markets. In India, interest rates are far too high. Besides this, many non-resident Indians are buying short-term Indian deposits to take advantage of interest rate differential in India and outside India. The widening of trade deficit - the net difference in imports and exports - on account of a higher import bill has also caused a rise in external debt. A depreciation in rupee has made debt costlier as it must be paid back in the same currency it was loaned in.
Impact
A rise in external debt - especially short-term debt - increases a country's vulnerability to capital inflows. This is even more risky now as the US Federal Reserve has indicated a withdrawal of its bond-buying program, which had led to influx of foreign funds into emerging markets like India. Foreign investors have thus moved their funds out of emerging markets, thus resulting in a net outflow of funds. Financing would be a challenge in India. This will in turn put pressure on its forex reserves, which are now at its lowest levels since 1997.
At a time when the rupee has depreciated to its all-time low against the dollar, the RBI needs sufficient forex reserves to stem the free-fall. A rise in debt, thus, puts pressure on the rupee too.
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