Rupee Depreciation and Its Impact on Indian Corporates with Foreign Borrowings
The depreciation of the Indian rupee against the US dollar has emerged as a major challenge for Indian corporations that have opted for foreign currency borrowings. The decline in the rupee’s value has significantly increased the cost of debt servicing, adding to financial stress in an environment already affected by global trade tensions, economic slowdowns, and rising interest rates.
The 5% decline in the rupee since April 2024 has resulted in an equal increase in the cost of repaying external commercial borrowings (ECBs). This has created a substantial burden for corporates that have not adequately hedged their forex exposure. The situation is likely to worsen as the Reserve Bank of India (RBI) has indicated that it is open to a steady depreciation in the rupee, prioritizing market stability over defending a specific exchange rate level.
Rising Costs of External Commercial Borrowings
For many years, Indian companies have turned to foreign loans as an attractive alternative to domestic borrowing, especially when the interest rate differential between India and the US was as high as 5% in 2020. Borrowing in foreign currencies was cost-effective at that time due to the lower interest rates offered by international lenders. However, with the US Federal Reserve aggressively increasing interest rates, the advantage of these loans has diminished.
The appreciation of the US dollar has increased the rupee-equivalent cost of repaying foreign loans. Companies that failed to hedge their foreign currency exposure are now facing serious financial strain. A depreciation of just 3.2% in the last three months has already begun to impact businesses that borrowed in foreign currencies, as the amount they owe has risen in rupee terms.
For instance, a company that borrowed ₹2,000 crore in foreign loans without hedging is now dealing with the impact of higher repayment obligations. If the loan was taken five years ago, the depreciation burden would now exceed 22%, in addition to the 6.6-7% annual interest rate on such loans.
The Role of the RBI and Its Stance on the Rupee
The Reserve Bank of India (RBI) has stated that its intervention in the forex market is aimed at controlling volatility rather than maintaining a specific exchange rate. RBI Governor Sanjay Malhotra recently emphasized that the central bank does not target a particular rupee-dollar exchange rate but rather works to prevent excessive and disruptive movements in currency values.
While the RBI has intervened in the past to stabilize the rupee, it has allowed a gradual depreciation in line with other global currencies. This approach aligns with the broader policy of ensuring that Indian exports remain competitive in the global market. However, this also means that corporates holding foreign currency debt need to brace for increased repayment burdens in the coming quarters.
How Rupee Depreciation Increases Corporate Debt Burden
When an Indian company borrows money from foreign lenders, it does so in a stronger currency like the US dollar or the euro. The initial loan amount, interest payments, and principal repayments are all denominated in foreign currency. A depreciation in the rupee means that Indian companies have to pay more rupees to buy the same amount of dollars for debt servicing.
For example, if a company took an external commercial borrowing (ECB) of $500 million at an exchange rate of ₹75 per dollar, the total loan amount in rupees would be ₹37,500 crore. If the rupee depreciates by 5% to ₹78.75 per dollar, the loan burden in rupee terms automatically increases to ₹39,375 crore.
This ₹1,875 crore increase in liability is solely due to currency fluctuations, and this is without any changes in interest rates or additional borrowing costs. Companies that fail to hedge their forex exposure may see their financial obligations increase drastically, leading to liquidity challenges.
Industries Most Affected by Foreign Borrowings
The impact of rupee depreciation is not uniform across all industries. Some sectors are more exposed to foreign borrowings and dollar-denominated liabilities than others.
Infrastructure and Power Sector
Many Indian infrastructure companies, including those in the power, road, and renewable energy sectors, have raised funds through foreign currency loans. Given the long-term nature of these projects, currency depreciation significantly raises capital costs, making projects less viable in the long run.
Pharmaceutical and Healthcare Sector
Indian pharmaceutical companies, which rely on imports for raw materials and active pharmaceutical ingredients (APIs), are facing rising input costs. Additionally, large pharma firms with foreign currency loans for international expansions will see an increase in repayment obligations.
Aviation Sector
Airline companies, which lease aircraft and purchase aviation fuel in dollars, are also among the worst affected by rupee depreciation. A weaker rupee leads to higher lease payments, maintenance costs, and fuel expenses, putting additional pressure on their financial performance.
Information Technology (IT) and Export-Oriented Sectors
On the flip side, IT companies and export-oriented sectors such as textiles and automotive components benefit from a weaker rupee because they earn in dollars but incur a majority of their costs in rupees. While exporters benefit, companies with significant foreign borrowings face higher debt servicing costs.
The Role of Hedging in Managing Forex Risks
To protect themselves against currency volatility, Indian companies with foreign borrowings must implement effective hedging strategies. Hedging involves using financial instruments like forward contracts, options, and swaps to reduce exposure to currency fluctuations.
However, many companies, especially those in the mid-cap and small-cap segments, fail to hedge their forex risks due to the additional costs involved. This lack of hedging results in unexpected financial stress when the rupee weakens.
Large corporates with strong financial management teams usually hedge a significant portion of their foreign debt, shielding them from extreme currency movements. On the other hand, companies that leave their forex exposure unhedged are now facing higher repayment costs and potential liquidity challenges.
Impact on Indian Stock Markets and Investor Sentiment
The depreciation of the rupee and its impact on corporate foreign borrowings also affects investor sentiment in the stock market. Foreign institutional investors (FIIs) often pull out money from Indian equities when the rupee weakens, as it reduces their returns when converted back into dollars.
Stock prices of companies with large foreign debt burdens tend to decline during periods of sharp rupee depreciation, as investors factor in higher interest expenses and repayment risks. This trend was evident in recent weeks when stocks of infrastructure, pharma, and aviation companies saw a decline in response to rupee depreciation concerns.
On the flip side, stocks of export-oriented firms like IT services and select manufacturing companies saw gains due to expectations of improved profitability from higher dollar-denominated earnings.
Future Outlook: More Pain for Borrowers?
The outlook for the rupee in the coming months will depend on global macroeconomic factors, RBI policies, and investor sentiment. Given the U.S. Federal Reserve’s stance on keeping interest rates elevated, the dollar is likely to remain strong, putting further pressure on the rupee and Indian companies with foreign borrowings.
If the rupee continues to weaken, corporates relying on ECBs may face additional repayment burdens, which could impact profitability, capital expenditure plans, and overall financial stability.
The RBI’s decision to let the rupee adjust gradually rather than actively intervening suggests that companies will need to take proactive measures to manage currency risks. Businesses with unhedged foreign loans must now reassess their risk management strategies to avoid further financial strain.
Conclusion
The depreciation of the rupee has compounded financial risks for Indian corporates with foreign currency borrowings. As repayment costs rise, companies that failed to hedge their forex exposure are now grappling with higher debt obligations. While exporters may benefit from a weaker rupee, firms with significant foreign borrowings are at risk of financial stress.
The situation underscores the importance of effective currency risk management, particularly in an environment of global economic uncertainty and rising U.S. interest rates. Moving forward, corporates will need to adopt robust hedging strategies and assess their capital structures carefully to mitigate risks from future rupee depreciation.
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