FII inflows have been returning to EMs of late and India has been one of the recipients with net monthly inflows to India turning positive since June after strong outflows from March to May. In line, India has been piling up its FX reserves as buffer, without which the INR would have appreciated further. While further accumulation would depend on the strength of the USD (contingent on ongoing fiscal spending by the US government, path of Covid-19 and associated global economic recovery) and foreign inflows, the higher cushion provides stability to INR and credibility with foreign investors.
Figure 1: India’s increase in FX reserves has been one of the highest among EM peers
In this context, we look at India’s external debt profile, the adequacy of its foreign reserves, how all this has changed in the last 15 years and various scenarios of reserve drawdown. We explore this through a series of charts.
Figure 2: India's external debt has reduced from 24.2% of GDP in FY14 to 19.5% in FY20
Figure 3: India's external debt growth has been mostly benign since late 2014, moving either closely or quite below (June 2016 to June 2018) the growth in nominal GDP
Figure 4: Seen differently, flow of external debt has slowed considerably. It fell by 61% during FY16-FY20 vs. FY11-FY15.
To further understand the dynamics of the slowdown in external debt, we need to understand how the long-term and short-term categories, and its constituents, moved over the years.
Figure 5: Looking at the split of long-term external debt by borrower/sector, the total flow during FY16-FY20 fell very sharply from FY11-FY15 for the financial sector (to USD 36bn from USD 89bn) and the non-financial private sector (to USD 8bn from USD 48bn). These two accounted for 68% of the long-term external debt outstanding in FY20. However, there was a revival in long-term external debt raised in FY20, led by the non-financial sector
We now break down the same long-term external debt into the two main categories.
Figure 6: The two main categories of long term external debt, commercial borrowing and NRI deposit, slowed. The former is in line with lower borrowing by the non-financial private sector (seen above), while the latter was due to both lower oil prices from late-2014 to 2017 and the reversal of additional NRI deposits raised during the 2013 taper tantrum.
Figure 7: Short-term external debt flow also stayed weak all through FY14-FY17, but increased in FY18
Unsurprisingly, short-term external debt which is primarily trade related (95% of the total) is closely linked to the world export cycle. World export growth had contracted in 2015 and 2016 (quite sharply in 2015), after which it rebounded in 2017 as the global economy witnessed a synchronised pickup in growth.
We now look at the currency profile of India’s external debt.
Figure 8: Rupee denominated external debt share increased from 22% in FY14 to 36% in FY19, while USD-denominated debt fell from 61% to 51% during the same period. However, this trend reversed in FY20 as the share of rupee-denominated debt fell by 4ppts and that of USD-denominated debt increased by 3ppts. The reason for this - lower global interest rates, view of a weaker USD ahead, offsetting higher revenues in USD, etc. - is not entirely clear.
Figure 9: Consequent to the reduction in external debt, India’s external debt service ratio (defined as the ratio of external debt principal and interest payments to BoP current receipts) has slowed from its recent peak in FY16. The slight pickup in FY20 is in line with the revival of long-term external debt seen above.
We also analyze how the adequacy of India’s foreign reserves, to cover short-term external debt and imports of goods and services, have moved.
Figure 10: India’s share of short-term external debt in FX reserves increased sharply from FY08 and doubled in FY13 as borrowing increased and reserves stayed low. This has gradually moderated thereafter as overall debt flow was lower and accretion of reserves much higher. The import coverage ratio has improved from a low of 6.0 in FY13 to 9.5 in FY20 and 10.6 in July 2020. It could further rise if import demand stays subdued, ceteris paribus.
Source: CEIC, Department of Economic Affairs, IMF, IDFC MF Research. Note: 1) Import coverage ratio is defined as the number of months of imports of goods and services covered by FX reserves, 2) ST is ‘Short-Term’.
Figure 11: India’s foreign reserves have also stayed well above the IMF’s reserve adequacy measure and improved further in FY20
Source: CEIC, IMF, IDFC MF Research. Note: IMF Assessing Reserve Adequacy (ARA) metric is derived using weights to cover exports (potential loss of export income and liquidity stress on banks), broad money (risk of resident capital flight), short term debt (debt roll-over risk) and other liabilities (risk of non-resident debt and equity capital flight). The weights differ based on the exchange rate regime (fixed or float) of an economy. For India, given it has a floating exchange rate regime, it uses a weight of 5% for exports, 5% for broad money, 30% for short-term debt and 15% for other liabilities.
Finally, we observe how the various metrics of adequacy of India’s foreign reserves would look under different scenarios of a drawdown in reserves. This is not to suggest any potential drawdown but is essentially a stress-test of the cushion available in the event of a capital flight.
Figure 12: India’s various measures of reserve adequacy look quite comfortable at this juncture. Even when we model for various levels of drawdown (assuming all other variables remain constant), the measures don’t turn alarming. For reference, India's FX reserves were down by USD 66bn from end-May 2008 to end-January 2009 during the GFC (a fall by 21%)
Source: CEIC, IMF, IDFC MF Research. Note: 1) Short-term debt is based on residual maturity, 2) IMF ARA is IMF Assessing Reserve Adequacy metric, 3) For the latest actual situation, import and current account numbers are taken as at end-March 2020 while FX reserves are taken as at end-July 2020 and 4) In all the scenarios, we assume any FX intervention in sterilised and therefore does not impact money supply. Thus, the IMF ARA metric which has broad money in its calculation does not change.
SUMMARY:
India’s external debt addition has reduced in the last 5-6 years, with growth being close to or below nominal GDP growth. This slowdown has been led by both the financial and non-financial private sectors in the long-term segment. In line, both external commercial borrowings and NRI deposits have slowed. Short-term debt flow, mostly trade-related, picked up in 2017 as world exports rebounded but has been flat thereafter. In terms of currency denomination, we see the increase in rupee-denominated debt since FY15 reversed partially in FY20. All this means the external debt service ratio has been improving but increased marginally in FY20 due to the rebound in long-term debt.
Adequacy of India’s foreign reserves has increased since FY13, not just owing to lower debt but also due to the aggressive addition to its reserves, and remain comfortable at the moment. Under various stress scenarios of drawdown of reserves, we see the adequacy does not fall drastically. This is indeed India’s silver lining in the current domestic and global economic backdrop.
In a follow-up note, we will compare some of these external account parameters (external debt, reserve adequacy, IIP, etc.) for India vs. its EM peers. We would also look at how their foreign reserves were managed and currencies fared during the GFC and taper tantrum.
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