In our recent note we looked at how India’s external debt addition has slowed over the years led by both financial and non-financial private sector enterprises. We also saw the adequacy of its reserves improved since 2013 and is unlikely to fall materially under various stress scenarios, which makes it India’s silver lining in the current economic backdrop. In this note, we compare India’s external debt and reserve adequacy with some of the other Emerging Market (EM) countries. We also study how these countries managed their reserves and how their currencies fared during previous episodes of stress, such as the Global Financial Crisis (GFC) of 2008 and the taper tantrum of 2013.
Figure 1: India’s total external debt (as a percentage of GDP) has historically stayed quite low vs. peers. In 2019, it was only marginally above its own 2010-share of GDP, owing to the lower addition to external debt in the last 5-6 years. For most peers, it actually increased in the last 10 years.
Source: CEIC, IMF, IDFC MF Research. Note: GDP is Gross Domestic Product
Getting straight to foreign reserve adequacy, we look at how much of imports, short-term external debt, etc. is covered and also the International Monetary Fund (IMF) reserve adequacy metric.
Figure 2: Import cover has stayed quite flat over the years but only Brazil, China and Russia had a higher cover in the peer-set as of 2019
Source: CEIC, IMF, IDFC MF Research
Figure 3: In terms of the share of short-term external debt in reserves - apart from Malaysia, Turkey and South Africa which have a > 100% share - India is the highest among the remaining nine countries. Its share has also increased quite a bit in the last ten years. Nevertheless, the ratio is not alarmingly high and the margin of difference with the other countries is also not very high.
Source: CEIC, IMF, IDFC MF Research
As a more comprehensive check, we now compare the adequacy of reserves to cover both short-term external debt and the current account balance. So if a country has a current account surplus, it reduces the need for cover, and if it has a current account deficit (like India), it increases the need for cover.
Figure 4: The more-comprehensive measure also suggests India’s number is higher than seven of the eleven peers. However, this measure has not increased as sharply as the previous one (see Figure 3) in the last ten years, given the improvement in India’s current account deficit post the taper tantrum episode in 2013. Again, the share is not drastically high in an absolute sense.
Source: CEIC, IMF, IDFC MF Research
Figure 5: India’s foreign reserves being well above the IMF reserve adequacy measure suggests its comfort in handling its short-term liabilities. The margin of comfort is also better than most of the countries in the peer set
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 s tress 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.
To understand how various EM countries used their reserves during previous episodes of economic turmoil, we look at the GFC and taper tantrum periods. We also look at the hit their currencies took.
Figure 6: The GFC episode - India drew down its reserves by 21%, to defend its currency, while many other EMs chose to use less and instead let their currencies depreciate more. This was a function of the reserve adequacy, as almost all the countries which used less of their FX reserves had inadequate or only just-adequate foreign reserves then (see Figure 5). It could also have depended on the acceptable range of currency value.
Source: CEIC, IMF, IDFC MF Research. Note: USD is U.S. Dollar.
Figure 7: The taper tantrum episode - India raised rates and tightened liquidity, while it eased them during GFC, owing to the inherent difference in the nature of the crisis. It raised gold import duties sharply to reduce its unsustainably high current account deficit and attracted foreign capital through Foreign Currency Non Resident Account (FCNR) deposits. Thus, the nature of the episode and lines of defense were different. The current crisis is thus more comparable to GFC.
Source: CEIC, IMF, IDFC MF Research
Summary:
We saw India’s external debt addition slowed over the years and its reserve adequacy improved since 2013, making it unlikely for its reserves to become ‘inadequate’ in the event of a drawdown. While the import cover of its reserves is higher than most other peer EM countries, the share in reserves of a) short-term external debt and b) short-term external debt plus current account balance is higher than many peers, although not by a very high margin. However, as per the IMF reserve adequacy measure, India’s reserves have a higher margin of comfort than most other EMs. Finally, from the GFC episode, we see reserve adequacy impacts the quantum of utilisation of reserves across EMs if a drawdown to support its currency is required. The taper tantrum episode was however inherently different which elicited a different set of response.
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