It is a known fact that India Inc has long been plagued with burgeoning debt and has been facing a crisis when it comes to repayments. While debt restructuring is the most common method to overcome this menace, lately dollarisation has been used as a quick fix to overcome this predicament. As explained by Investopedia; dollarisation is a method by which the companies/banks/citizens of a particular country can use a foreign currency for carrying out transactions.
Corporates in India use dollarisation to roll over their rupee liabilities into foreign currency liabilities. Dollarsiation of debt not only saves interest cost (as a result of lower interest rates in foreign countries) but also helps extend the maturity period of the debt. Since the interest cost is saved, companies also have additional liquidity at their disposal. Also, in case of companies where the earnings are also in foreign currency, dollarisation of rupee debt could also de-risk its balance sheet. As per an article in Business Standard, of late, many companies have dollarised their debt liabilities. While dollarisation benefits companies, banks also encourage it as it helps them keep sticky loans out of their non performing assets (NPA) .
Unfortunately, the RBI's recent restrictions on using dollar denominated debt could prove to be a death knell for Indian companies used to this practice. In its recent policy, RBI has ruled that banks can no longer extend loans or guarantees which can be used to convert borrowers' existing rupee loans into a foreign currency. With this move, RBI intends to curb instances where the mechanism is used to shift liabilities to the offshore entities of Indian banks or to convert rupee liabilities into non-fund based foreign currency liabilities. This restriction came after debt of large Indian companies increased by whopping 137 %, while their EBITDA growth was restricted to 90% between FY10 and FY13. IMF too raised concerns over un-hedged foreign currency exposure of Indian companies through this route.
Dollarisation also has several other pitfalls. Firstly, on a large scale, it increases external debt of the country as a result of increase in external commercial borrowings (ECBs). This adversely impacts the debt to reserve ratio. Secondly, increasing dollarisation of liabilities of Indian corporates could lead to asset liability mismatch between rupee denominated income and dollar-denominated liabilities. In order to match asset liability; it is imperative that the debt of the company is aligned to the earning currency. Since foreign currency debt has to be reinstated at the exchange rate prevailing at the close of balance sheet; a company's debt can go up due to rupee depreciation.
RBI's decision to restrict dollarisation is a step in the right direction. It shall take care of the above discussed shortfalls and prevent misuse of this route by corporates and banks. In addition, it will also give a correct picture of the banks' asset quality. At the same time the restriction to resort to ECB will increase the quantum of non performing assets. While, it may further pressurise the banking system as delinquencies will rise; it may also lead to greater and more transparent disclosures. This means that now debt restructuring is the best possible route to deal with the sticky loans and NPAs till the time the structural problems within the economy are resolved and business scenario improves for corporates.