External Commercial Borrowing

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Indian Institute of Management Calcutta

Working Paper Series

WPS No. 802

November 2017

India’s External Commercial Borrowing: Trends, Composition, and Determinants

Partha Ray

Professor, Indian Institute of Management Calcutta

D. H. Road, Joka, P.O. Kolkata 700 104

Abhisek Sur

Doctoral Student, Indian Institute of Management Ranchi

Suchna Bhawan, Meurs’ Road, Ranchi 834008

Amarendu Nandy

Assistant Professor, Indian Institute of Management Ranchi

Suchna Bhawan, Meurs’ Road, Ranchi 834008

India’s External Commercial Borrowing:

Trends, Composition, and Determinants

Partha Ray

Professor, Indian Institute of Management Calcutta

Email: pray@iimcal.ac.in

Abhisek Sur

Doctoral Student, Indian Institute of Management Ranchi

Suchna Bhawan, Meurs’ Road, Ranchi 834008

Email: abhisek.sur15fpm@iimranchi.ac.in

Amarendu Nandy

Assistant Professor, Indian Institute of Management Ranchi

Suchna Bhawan, Meurs’ Road, Ranchi 834008

Email: amarendu@iimranchi.ac.in

Abstract. With the turn of the century, external commercial borrowings (ECB) has assumed prominence in India’s capital account and evolved as a preferred medium of overseas borrowing of select corporates. It accounts for about two-fifths of India’s external debt in 2015. The objective of this paper is to study the trends, composition, and determinants of ECB in the Indian context for the period 2000 to 2015. It contributes to the extant literature in a number of ways. First, unlike other scholarly in the Indian context, this study focuses exclusively on ECB, and not as a constituent of capital flows. Second, it weaves the macroeconomic trends and changes in the regulatory regime, with ECB flows, covering the pre and post global crisis period. Finally, employing the Johansen cointegration and the error correction model, the paper investigates the role of domestic and global factors in influencing the ECB flows to India. Results suggest that while both the domestic and international factors significantly influenced ECB flows to India, the later seemed to dominate. The paper recommends that focusing on domestic economic fundamentals and adopting a cautious approach to capital account liberalization will be imperative for stabilizing the ECB flows.

Key Words: External commercial borrowing, capital account openness, external debt, India.

JEL Classification: F41, F20, E58.

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India’s External Commercial Borrowing:

Trends, Composition, and Determinants

1. Introduction

In a caricatured simplified world, a firm can have the following three broad sources of finance: equity, debt, and borrowing. In each case, in terms of origin, funds can come from domestic and external sources. Relatedly, when one looks at a Balance of Payments (BoP) representation of a country, the major items in capital account are investments and borrowing. Within borrowing in terms of ownership of sources, one can make a further subdivision into official versus commercial. The purpose of this paper is to look into trends, composition, and determinants of this particular subcategory, i.e., external commercial borrowing (ECB).

External commercial borrowings (ECB) has emerged as an important item of the capital account in India’s Balance of Payments (BoP) and is a key channel to facilitate access to foreign capital by Indian corporates and public sector units (PSUs). ECBs are commercial loans in the form of bank loans, buyers’ credit, suppliers’ credit or securitized instruments availed from non-resident lenders with a minimum average maturity of 3 years, and can be obtained through two routes, the automatic route and approval route. ECB regulations in India are monitored by the Reserve Bank of India (RBI) in consultation with the Ministry of Finance, Government of India, and are guided by the broad guidelines that govern the capital flows to India, and falls within the framework of the Foreign Exchange Management Act (FEMA), 1999.

Indian corporates’ access to foreign borrowing was limited to bilateral and multilateral arrangements during the initial three decades after independence. However, in the 1980s when external assistance was not preferred because of the burgeoning debt, ECB evolved as a preferred medium and continued to increase till the onset of the BoP crisis in the early 1990s. During the period, ECBs, like all other capital flows ebbed to historical low levels on account of low investor confidence resulting from the poor sovereign risk ratings.

Nevertheless, a prudent external debt management policy together with the introduction of the liberalization scheme helped India tide away the BoP crisis. Although India

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adopted a calibrated approach in its capital account management, it moved to a floating exchange rate system from a pegged exchange rate, which ultimately led to the current account convertibility in 1994. Significant reforms were also introduced in India’s external sector since the early 1990s. External financing, including debt flows, has generally financed the current account deficit in India (Mohan and Ray, 2017).

As India embarked on the path of globalization and liberalization following the BoP crisis in the early 1990s, the composition of capital flows witnessed a paradigm shift from official transfers to private capital inflows (Gopinath, 2004) and ECB emerged as the prime component of debt creating capital flows. With the changing contours of capital flows to India, the composition of India’s external debt has also undergone significant changes.

As of end March 2015, India’s total external debt was US$ 475.8 billion (23.8 percent of GDP), and ECB alone accounted for about two-fifths of India’s external debt. Over the years, the dwindling of external assistance in India’s external debt became evident. While in 1990-91, multilateral and bilateral flows together constituted more than 40 percent of India’s external debt, ECB accounted for only about 12 percent. However, over the years, the scenario has reversed, and ECB has emerged as a prime component of India’s external debt. As of end March 2010, ECB accounted for about 27 percent of India’s external debt which increased by more than 11 percentage points in a span of five years to 38.2 as on end March 2015. A host of factors like, increased integration of the Indian economy with the global economy and robust growth prospects of the domestic economy perhaps fueled the dominance of ECB (RBI, 2015).

The extant literature on ECB in the Indian context, especially the macroeconomic studies has studied ECB in the context of capital flows (Chakraborty, 2006; Singh, 2009; Verma and Prakash, 2011). Although Singh (2007) studies ECB standalone, the study covers the pre-crisis period only and focuses primarily on the domestic factors like interest rate, activity in the real sector and credit constraint in the domestic economy influencing overseas borrowing behavior by Indian corporates.

This present paper while embedded in the existing literature goes further in the following respects. First, it looks into ECB as its prime focus and not necessarily as a constituent

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of capital flows. Second, it weaves the macroeconomic trends and changes in the regulatory regime, with ECB flows. Third, it covers the time-period till 2015, thus encompassing the global financial crisis period. Finally, it goes beyond the stylized facts and in the backdrop of a modified Mundell-Fleming model seeks to identify the factors influencing the flow of foreign private capital flows. Specifically, we identify factors like international liquidity, capital account openness, sovereign credit ratings, and exchange rate that has not been captured in past studies on ECB in the Indian context. Even as we try to investigate the impact of the growth potential of the domestic economy in influencing ECB flows, we consider it relative to the world growth rates, thus giving a new dimension. Using quarterly data from 2000 to 2015, we employ the Johansen cointegration approach and develop the error correction model (ECM) to investigate a long run relationship of ECB with both domestic and global factors in a VAR (Vector Auto Regressive) framework.

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