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Impact on the Indian Corporates

As a result of deterioration in global financial market conditions, spreads on corporate debt might widen suddenly due to shift in investor confidence in the global financial markets. Increase in the global interest rates may also have impact on other benchmarks such as LIBOR. A sharp rise in yields may entail an increase in cost of variable-rate debt contracted by the corporates. This, to some extent, could be offset if there is a depreciation of the relevant currency and consequent decline in the value of the existing debt contracted by corporates in that currency.

Indian corporates as also some of the public sector enterprises raise resources from the international capital markets. While a part of their external commercial borrowings is at variable interest rate, a part is at fixed interest rates. In order to avoid any serious impact of changes in the exchange rate on the balance sheet of the corporate sector, Reserve Bank has been advising banks to regularly monitor the unhedged position of the corporates and has also been exhorting corporates to hedge their foreign exchange exposures. Thus, India's corporates could be affected by the deterioration in the financing conditions only to the extent they are not hedged either by foreign-currency cash flows in the normal course of business or through recourse to appropriate hedging products. Corporates would, however, be affected to the extent interest rates firm up in the domestic market, depending on their exposure to debt relative to other liabilities.

Impact on the Banking Sector

Banks in India are dependent mainly on domestic deposits, predominantly at fixed rates, for their resource requirements. They would, therefore, be impacted significantly only if the adverse developments in the international capital markets are particularly severe. Banks, in general, also do not hold stock of securities in foreign currency. Banks in India have, thus, relatively small exposure to the foreign exchange market. Their foreign currency borrowings are subject to the prudential limit of 25 per cent of their Tier-I capital and they are also required to maintain capital against the net open position. Foreign currency borrowings by the banks are permitted beyond this ceiling, which is linked to the net worth, exclusively for the purpose of export finance.

Like many other emerging market economies, credit extended by banks in India has increased sharply in recent times. Credit growth, which was earlier seen largely in housing and retail loans, has now turned quite broad-based with agriculture and industry also joining to drive up the credit demand. The credit growth in some sectors, specially those related to assets which are experiencing price volatilities, is being monitored closely.

Banks are allowed to lend to resident exporters in foreign currency at internationally competitive rates of interest from their foreign currency lines of credit as well as out of funds available in exchange earners' foreign currency accounts, resident foreign currency accounts and foreign currency non-resident (banks) accounts. These loans are intended to finance domestic and imported inputs for export production. Foreign currency loans to exporters are generally hedged against credit risk since they are extended for bona fide underlying activity viz., export production. They are also usually covered for exchange risk since they are denominated in foreign currency. Banks are also allowed to extend loans in foreign currency to non-resident Indians against their FCNRB deposits. Funds in foreign currency deposits can also be utilized for lending to domestic corporates for working capital requirements in India, import financing, purchase of indigenous machinery, repayment of rupee term loans and external commercial borrowings.

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