Harun R Khan: Emerging trends in the global financial landscape -
India's challenges and opportunities
Based on the inaugural address by Mr Harun R Khan, Deputy Governor of the Reserve Bank
of India, at the Third International Conference on Emerging Trends in The Global Financial
Landscape organised by the Symbiosis Centre for Management Studies, Pune, 23 February
2015.
* * *
The speaker acknowledges the contributions of Shri. R Subramanian & Shri. Surajit Bose of the Reserve Bank of
India.
1. Good morning Symbiosis. Dr. Rajani Gupte, Vice Chancellor, Symbiosis International
University, Dr. Bhama Venkataramani, Director, Symbiosis Centre for Management Studies,
Mr. Y.M Deosthalee, Chairman & MD, L&T Finance Holdings Ltd., Mr. Alexander K. Sattler,
Financial Counsellor & Representative of the Deutsche Bundesbank, members of faculty,
students, distinguished invitees and friends from media. It is a pleasure to be in your midst
and inaugurate the Third International Conference on Emerging Trends in The Global
Financial Landscape. Last seven years have been quite eventful and interesting for all and
especially for the policy makers across economies. Crisis after crisis have tested existing
policies, forced reorientation of many policies and led to adoption of unconventional policies.
In short, the intensity of global financial crisis of the recent past has been such that the
financial landscapes have undergone tectonic shifts. Against this background, I would begin
with a brief review of the key developments that shape our global outlook at this point of time
and the impact of such changes on India. I would briefly highlight the impact of major crises
in the past vicennium and then touch upon the various dimensions of India's increasing
linkages with the global financial landscape besides current state of external sector
vulnerability. Finally, before summing up, I would briefly cover the issues related to foreign
exchange reserves which act as the first line of defence when faced with external sector
vulnerabilities and volatilities.
A. Global outlook
Developed economies
2. The IMF has projected1 global growth in 2015-16 at 3.5 and 3.7 per cent. The projections
are 0.3 per cent lower than what was projected in its World Economic Outlook in October
2014. The revisions reflect a reassessment of growth prospects in China, Russia, the
Eurozone, Japan and some oil exporting countries. World trade volume and consumer prices
in advanced economies are also projected to decline. The World Bank, in its Global
Economic Prospects Report, January 2015, has reduced global growth projection for 2015
from 3.4 per cent to 3.0 per cent. Japan has come out of a technical recession but is still
quite some distance away from the Bank of Japan's target of 2 per cent inflation. The Bank of
Canada and the Reserve Bank of Australia have announced rate cuts in view of weak
growth. Global growth, therefore, continues to be in a sluggish phase, which has been
characterized as "secular stagnation" by Larry Summers.2 The US offers the best prospects
in the developed world but Eurozone continues to be a matter of concern even as the
European Central Bank embarks on quantitative easing (QE) programme to fight deflation.
Greece continues to trigger fears of a renewed Eurozone crisis though the European Finance
Ministers appear to have reached an agreement to extend Greece's financial rescue plan for
another four months. The possibility of a Grexit, however remote, may induce a chain of
events which markets may not be prepared for. Ukraine and the Middle East are sources of
geopolitical risks. Given the prospects in the US economy, the US dollar has strengthened
against most currencies and, in particular, against the Euro, Canadian Dollar, Australian
Dollar and the Japanese Yen. With a stronger US dollar and low oil prices, what is of interest
is the policy course the US Federal Reserve is likely to pursue - when it will take the first
step in a cycle of rate rise and, subsequently, at what pace will it tighten monetary conditions.
Emerging market & developing economies
3. The recent update on the IMF World Economic Outlook projects that growth in Emerging
Markets & Developing Economies (EMDEs) to remain broadly stable at 4.3 per cent in 2015
and to increase to 4.7 per cent in 2016 - a weaker pace than forecast in October 2014.
Projection for growth of Indian economy was marginally revised downward from 6.4 per cent
to 6.3 per cent. The World Bank, in its Global Economic Prospects Report (January 2015)
has also cut down the growth projection of EMDEs from 5.2 per cent to 4.8 per cent for the
year 2015. This is mainly attributed to lower growth in China, a much weaker outlook in
Russia and downward revisions to potential growth in commodity exporting countries.
Deceleration in growth in China has been well known. To an extent, slower growth is policy
induced by the Chinese authorities as they aim to reduce vulnerabilities from rapid credit
growth and make a transition from an investment-led economic model. What needs to be
seen is whether China makes a soft landing and what are the implications for the rest of
Asia. Any policy move by China to ease monetary policy will have ripple effect across the
Asian region. As regards capital flows to the EMDEs, the Institute of International Finance
(IIF) expects 2015 could be another stressful year for capital flows to emerging markets.
Total EMDE inflows are projected to decline further, after a substantial drop last year, as the
Federal Reserve starts to raise the policy rates and the EMDE growth remains lackluster.
Flows during the year are again likely to be volatile, as markets are affected by shifting
expectations of the Federal Reserve's policy trajectory, oil market uncertainty and political
risks. Country differentiation, a subject eloquently brought out in Ruchir Sharma's book
"Breakout Nations: In Pursuit of the Next Economic Miracles", will continue to remain a key
theme for 2015. While many large EMDEs with well-known vulnerabilities have sought to
strengthen their macro policy frameworks, and benefit from lower oil prices, analysis of past
Federal Reserve tightening cycles suggests risks of heightened incidence of EMDE crises
during the year ahead. There are fears that EMDE markets may be catapulted into currency,
sovereign or banking crisis as years in which the Federal Reserve has tightened monetary
policy usually have seen more market turmoil. While the EMDE capital flows could be
affected, the key question is how sensitive are these to US rate rise. According to IIF's
estimates a 0.5 per cent rise in rates, all other things being equal, will sap flows in EMDE by
about 10 per cent or US$ 30 billion. This year could, however, be different as the European
Central Bank and the Bank of Japan are both following ultra-accommodative monetary
policies. This should soften the blow of a US rate rise.
4. What is of concern is the market's discounting of the Federal Reserve's own predictions
for future rate rises. The disparity between what the Federal Reserve predicts about the path
of rate rise and what the market expects it to do has been well known. A quicker and steeper
than expected rate rise cycle in the US would have an impact on EMDE capital flows.
Throughout the past year, the VIX3 has been averaging about 14.2, its lowest since 2006.
The long term average has been 19.6. Any rise in the VIX could trigger a capital outflow from
the EMDE.
Outlook on oil prices
5. The sharp decline in global oil prices has been well documented in the financial press.
While the drop in prices was over 50 per cent since mid-2014, recent weeks have seen an
uptick in prices. The up move of about 20 per cent has also been somewhat unexpected at a
time when many analysts were expecting oil prices to fall further. The international oil price
movement has been the subject of market speculation as well as academic research. Oil
prices, as you are aware, reflect not only basic economic forces of demand and supply but
also geo-political developments, technological advances in renewal energy, climate change
and adoption of energy efficient technology.
6. Changes in production and consumption seem to fall short of a fully satisfactory
explanation of the abrupt collapse in oil prices. While oil production has been close to
expectations, consumption has been only a little less than earlier forecast. Most analysts
seem to agree that daily demand for oil is short of average daily production of a little over
94 million barrels per day by just about 1.5 million barrels. The Bank for International
Settlement (BIS), in a recent note4 has said that the steepness of the price decline and very
large day-to-day price changes are reminiscent of a financial asset. The Organization of the
Petroleum Exporting Countries (OPEC) decision not to cut production, no doubt, has been a
key factor in the fall in international crude price. But, as the BIS study shows, other factors
could have exacerbated the fall in oil prices. One important factor could be the substantial
increase in debt borne by the oil sector in recent years. Given high debt issued by oil
producers, in expectation of high future oil prices, an unanticipated fall in oil price weakens
the balance sheet of oil producers who are impelled to sell forward more of their production.
Further, debt service commitments may induce producers to maintain production levels and
delay production cuts, thereby keeping supply at a level higher than what demand may
justify. It has also been noticed that swap dealers may have become less inclined to sell
protection to oil producers during times of heightened volatility and balance sheet stress.
More study is of course needed to understand the oil price dynamics and its interactions with
financial markets and macro-economic factors.
7. Oil producing countries, facing an oil shock of a different kind, are also beginning to review
their national budgets which depend on oil revenue. The impact across countries has been
asymmetric - most Gulf nations and Norway have built sufficient reserves in their sovereign
wealth funds (SWFs). But some other high cost producers could be at risk if price continues
to fall. In recent weeks, the trend seems to have reversed and, ironically, market analysts
seem to welcome the move as the oil price equilibrium appears to be somewhat restored.
B. India and the global financial landscape
8. With that background, let me turn to the Indian context: Where is India placed in the global
financial landscape? India is perhaps the only major economy where growth prospects have
not been revised downwards. When its peers in the BRICS group seem to be following with
China on a slowdown trajectory, Brazil staring at stagflation, Russia reeling under recession
and South Africa facing declining growth, India is emerging as the leading light of the
EMDEs. Political stability combined with strong commitment to fiscal and monetary discipline
and economic reforms promise rapid growth. Given our advantages of demographic dividend
and a large entrepreneurial class, India should be the destination for global capital if we take
steps to address structural bottlenecks and enhance productivity of the economy.
The journey so far
9. Till the early 1980s, India's trade regime was autarkic with very high nominal import tariffs
and also non-tariff barriers. From the late 1980s, the government began dismantling the
import licensing system and simplifying the tariff structure moving towards a more open trade
regime. The crisis year 1990-91 was a watershed year in Indian economic history: India
faced an external payment crisis. Fundamental changes were carried out in industrial, trade,
banking and exchange rate policies.
Current account
10. Being a developing and energy deficient country, India's current account position has
always been in deficit barring for a brief period in the beginning of the last decade. India's
export performance has progressed commendably: exports have gone up from
US$ 18.1 billion in 1990-91 to US$ 314 billion in 2013-2014. The composition of exports has
shifted from labour intensive products (e.g., textiles) to capital intensive goods (e.g.,
engineering). India's trading partners have also changed with greater share of emerging
markets. Export of services has also seen phenomenal growth increasing from
US$ 4.6 billion in 1990-91 to US$ 151.5 billion in 2013-14. Concomitantly, merchandise
imports also rose as India's economy grew and progressively got integrated with the global
economy. Imports rose to US$ 450 billion in 2013-14 from US$ 24 billion in 1990-91. While
there has been rise in energy related imports, such as, oil and coal, import of precious
metals, particularly, gold also increased in the recent years. Notably, apart from the rise in
domestic consumption, sharp increase in oil imports was partly due to rising POL exports as
well. Overall, merchandise trade persistently remained in deficit. Invisibles, on the other
hand, have been a support with private transfers/remittances being steady and consistent.
India remains the largest recipient of officially recorded remittances in the world and received
about US$ 70 billion in 2013, covering about 15 per cent of imports. As a result, current
account deficit (CAD) generally remained range bound barring 2011-12 and 2012-13 when
it shot up to 4.2 per cent and 4.8 per cent of the GDP respectively. From second quarter of
2013-14, CAD has steadily declined and has been well within the sustainable range. Looking
at the recent trends, CAD increased to US$ 10.1 billion (2.1 per cent of GDP) in Q2 of 2014-
15 from US$ 7.8 billion (1.7 per cent of GDP) in the preceding quarter and US$ 5.2 billion
(1.2 per cent of GDP) in Q2 of 2013-14. The increase in CAD was primarily on account of
higher trade deficit contributed by both a deceleration in export growth and increase in
imports. With the steep fall in international oil prices, CAD during the current year as a whole,
however, is expected to be less than last year's figure of 1.7 per cent of GDP.
Capital account
11. India depends upon capital flows to bridge the CAD. Foreign Direct Inflows (FDI) and
portfolio investments constitute a major share of the flows. Debt flows, External Commercial
Borrowings, in particular, have gone up substantially but, as a share of total capital flows,
debt flows have declined from 80 per cent in 1990-91 to about 30 per cent in 2011-12. Total
capital flows reached a peak of US$ 107 billion in 2007-08 but collapsed to about
US$ 7.2 billion in 2008-09 indicating volatile nature of such capital flows. In the current fiscal
year so far, India has witnessed a net inflow of about US$ 25 billion in the form of FDI and
about US$ 36 billion as portfolio flows as against about US$ 21 billion and (-) US$ one billion
respectively in the corresponding period of the last year. During 2014-15, capital flows would
be more than adequate to finance CAD.
Impact of falling oil prices
12. The oil price fall has definitely been a boon to EMDE, especially countries like India
which are energy import dependent. It acts like a fiscal stimulus and world consumption is
expected to get a boost as consumers spend less on energy. The oil price decline is
beneficial to India, as it results in lower inflation and gives comfort in budget and fiscal
management. Crude oil import in 2013-14 was US$ 165 billion, about 36 per cent of the total
import bill. In April-November 2014, it was US$ 90.3 billion, about 28.3 per cent of total
import. According to some estimates, a US$ 10 a barrel fall in oil prices will reduce the
country's import bill and, hence, the CAD by US$ 10 billion or 0.48 per cent of GDP. Another
estimate indicates that 10 per cent reduction in crude oil prices will reduce Consumer Price
Index-based inflation by around 20 basis points (bps) and bring about a 30 bps rise in GDP
growth.
13. This provides an ideal setting to bring the current account back to health on a sustained
basis and as also work on fiscal consolidation. This is too valuable an opportunity for us to
miss. The oil price decline beyond the US$ 70-75 level has, however, given rise to
unexpected consequences. Is the fall in oil prices unambiguously good for the world
economy? Oil producers have been cutting back on future investments. This implies cutting
back on jobs in the oil and gas industry as well as support services. Energy stocks have
suffered losses. The fall in oil price seems to be the single most factor important behind
falling inflation in most economies. The fear of deflation grips central banks as consumption
could decline and real burden of debt will go up if inflation were to turn negative or remain
low for a long period of time. For India, the negative could be in terms of lower remittances
and capital flows from the affected countries.
C. Major crises in the past vicennium
14. The major crisis faced by India in the past are Asian Financial Crisis in 1997, LTCM &
Russian default in 1998, Dotcom Crisis in 2000, Subprime Crisis in 2007, European
Sovereign Debt Crisis in 2011 and Fed Reserve announcement of tapering in 2013. Talking
of the crises, Dr. D Subbarao, former Governor, Reserve Bank of India5 had said "... in
matters of economics and finance, history repeats itself, not because it is an inherent trait of
history, but because we don't learn from history and let the repeat occur." Hence, it is
imperative for EMDEs like India to internalize past crises and take effective steps to
safeguard against future shocks.
Impact of crises on India
15. These crises impact India in various ways. Firstly, increased volatility in the exchange
rate and equity markets could lead to depletion of foreign exchange reserves, weakness in
the economy, increasing threat of rating downgrades, diminishing investor confidence and
volatility in capital flows. Second, Balance of Payment (BoP) parameters come under stress
due to moderation in growth of major trading partners and commodity price volatility impacts
macro-economic parameters, such as, inflation and fiscal deficit. Third, corporates are
unable to raise foreign capital which imports financial problems from off-shore to on-shore
and unhedged foreign currency exposures translate into on-balance sheet concerns
impacting the credit worthiness of the corporates. Fourth, financial institutions experience
difficulties in accessing international financial markets. Fifth, monetary policies of developed
countries tend to impact macro-economic parameters of the country, e.g., recent experience
of announcement of tapering of asset purchase of the Federal Reserve. On May 22, 2013,
Chairman Ben Bernanke first spoke of the possibility of the tapering of Fed's purchases of
securities. This and subsequent statements collectively known as 'tapering talk', had a sharp
negative impact on the emerging markets. Around the period, domestic concerns pertaining
to high CAD, moderation in growth, high fiscal deficit, high inflation and policy uncertainty
were some of the major concerns for foreign investors.
16. The impact of announcement of tapering and domestic concerns was evident in the form
of tightening of liquidity and higher volatility in all market segments along with sharp decline
in stock prices. For example, during the period May 22, 2013 & August 30, 2013, the Indian
Rupee depreciated 15.5 per cent against the US Dollar, as against depreciation of 6.04 per
cent of Russian Rouble, 6.88 per cent of South African Rand and 14.08 per cent of Brazilian
Real. Equity markets declined with Sensex declining from closing of 20,062 on May 22, 2013
to 18,620 on August 30, 2013. Portfolio capital inflows which were buoyant till the third week
of May 2013 began retreating as US yield hardened and yield spread narrowed significantly.
Policy measures taken to curb volatilities
17. Reserve Bank had stepped in to curb excessive volatility in the foreign exchange market
and responded by increasing the short term interest rates and by tightening the Rupee
liquidity in the system. Special swap window was opened for public sector oil marketing
companies for meeting crude oil related dollar demand. Banks mobilized about US$ 34 billion
under FCNR (B) scheme and Offshore Foreign Currency Borrowings for augmenting the
foreign exchange reserves of the country. To ease pressures on rising CAD and discourage
import of gold, quantitative and other restrictions were placed on gold imports in consultation
with the Government of India. To further encourage longer term foreign currency inflows, the
external commercial borrowing mechanism was rationalized & liberalized and limits for
foreign investment in G-Sec were streamlined and increased coupled with relaxation in FDI
caps in some sectors.
D. The seven coupling channels
18. It is relevant to note that the Indian economy is now more interlinked with the world
economy than before; global developments have considerable influence on different
segments of domestic economy through various channels. With growing globalization and
integration with global economies, the spillover impacts can be felt through the following
seven channels (or the 7Cs) - Commerce, Capital Flows, Commodity prices, Confidence,
Carry Trades, Contamination and Central Banks' action & communication channels.
Commerce channel
19. For India, with its persistent CAD problem lower and sustainable level of CAD is very
important having far reaching implications on the policy making processes and also on the
way international institutions and investors view us. The earnings from export do provide
cushion in the balance of payments, aids in flexibility to import goods that are critical for our
development besides positive spillover effects on the domestic economy in terms of
improvements in quality and productivity.
20. Export sector faces a number of challenges, notable amongst them, are uncertain global
demand. The challenge is to search for new markets and new products for existing markets.
Whether our newly found export destination countries would remain insulated from the global
financial crisis? India's trade performance had improved significantly in 2013-14 led by a
modest growth in exports and compression in imports. While exports grew on the back of
stronger global demand and a more competitive Rupee in 2013-14, contraction in imports
was driven by decline in gold and non-oil non-gold imports. Exports have grown by 2.44 per
cent for the period April-January 2014-15 to US$ 265.03 billion from US$ 258.72 billion last
year. Over the same period, imports have grown by 2.17 per cent from US$ 375.25 billion to
US$ 383.41 billion. The trade deficit is marginally higher during April-January 2014-15 over
the previous year.
21. With the slump in international crude prices taking its toll on exports of petroleum
products, and non-oil export growth also decelerating sharply, merchandise exports shrank in
Q3 of 2014-15 after two consecutive quarters of growth. Export performance has been
hamstrung by weak global demand conditions and the persisting fall in unit value
realisations. The real appreciation of the Rupee may also have had some effect. The fall in
international crude prices translated into a sizable saving on account of POL imports, despite
a pick-up in import volumes in Q3. Gold imports also moderated, coming off the seasonal
cum pent-up demand spurt in September-November. On the other hand, non-oil non-gold
import growth remained firm and in positive territory, extending a run that began in May.
Although overall imports declined in December, they recorded an expansion for Q3 as a
whole on the back of the earlier rise in gold and non-oil non-gold items. As a consequence,
the trade deficit widened in Q3 relative to the preceding quarter. The estimate of the CAD for
2014-15 is currently placed at lower than previous year's figure. The CAD has been
comfortably financed by net capital inflows, mainly in the form of buoyant portfolio flows but
also supported by foreign direct investment inflows and external commercial borrowings.
Capital flow channel
22. Economies in emerging markets have been integrating with the global economy at a
rapid pace. Integration is driven by current and capital account flows. Investors of capital are
loyal only to assets and markets that promise the highest risk adjusted return. There is
always a tendency to retrace quickly when the risk-reward equation changes. Despite a high
domestic savings rate, India needs to import capital from abroad to support the second
highest growth rate in the world. The current account has been opened though gradually
over the last two and half decades. A more calibrated approach has been adopted towards
fuller capital account convertibility and for promoting capital inflows. Foreign direct
investments are permitted with an exception of a few sectoral caps in most of the sectors.
Portfolio investments in G-sec and corporate bonds are subjected to macro ceilings which
are subjected to modulation with evolving scenario. In debt flows, certain restrictions remain
including the overall quantum of external commercial borrowings, cost ceilings, end-use
restriction with focus on capex except a small window for general corporate purposes. As far
as financing of CAD is concerned, net capital inflows are expected to be more than adequate
in 2014-15.
Commodity price channel
23. Many EMDEs are dependent on import of commodities critical for their economic
development. The prices of these commodities are often characterized by huge volatilities. In
the Indian context, the largest contributor to CAD is oil imports and price of petroleum
products is an important factor to reckon with as also its inflationary impact. As our economy
grows, reliance on petroleum products has increased significantly and the increased demand
has to be met by higher imports. Last fiscal, India imported about US$ 150 billion worth of
crude which constitutes about 75 per cent of the total annual crude consumption. Thus,
spillover impact of price volatility of commodity like oil has huge impact on EMDEs like India.
Confidence channel
24. The impact of uncertainties of global financial conditions is evident through confidence
channel. The first market segment in India to be affected is the equity market. Of all markets
in India, equity is most accessible to foreign capital. For example, as per one estimate, as of
December 2014, foreign portfolio investors (FPIs) held 23 per cent of the market
capitalization and 47 per cent of the floating stock in the equity segment. Despite limits on
investments FPIs have also shown keen interest in taking exposure in debt securities for
higher returns. This could prove to be a major source of vulnerability. Global risk aversion
triggered by the European debt crisis caused a large correction and rapid outflows from
Indian equity, and more recently debt markets as was evident in the aftermath of taper talk in
2013. When international investors seek safe havens, the exchange rate markets are the
next market to be impacted. Equity and debt market correction is compounded by capital
outflows through demand for foreign currency. A downward spiral can ensue; thus,
threatening overall financial stability.
25. Transmission of impact of global crisis is accentuated with domestic vulnerabilities. The
impact of May 2013 announcement of the Fed Reserve was more pronounced due to
domestic vulnerabilities. The CAD had increased from about one per cent of GDP in 2006 to
nearly five per cent in 2013, real exchange rate had appreciated, fiscal deficit and inflation
had gone up. The economy had slowed down although the level of foreign reserves was
considered comfortable.
26. The confidence channel is also influenced by the credit rating action and outlook. Any
adverse move by international credit rating agencies affects the borrowing costs of the
corporates. It also affects capital flows and the exchange rate. Any resultant reversal in
capital flows would lead to fall in asset prices and volatility.
Carry trade channel
27. The "carry trade" is the most popular trading strategy in currency markets. Traders
borrow in currencies with low interest rates and invest in currencies with high interest rates
profiting from the margin. Prior to the global financial crisis, carry trades in Yen and
commodity currencies were common. In the recent past, with accommodative monetary
policies and near zero interest environments in developed economies, currencies of EMEs
have emerged as avenues of carry trade. The problem with currency carry trades is that they
are inherently unstable. The initial buying of the high yielding currency has the perverse
effect of pushing the currency higher, giving the impression of unidirectional bias and
complicating policy for the country as the overvalued exchange rate dents the country's
export competitiveness. In the event of unwinding of carry trades, which is generally sudden
and vicious as, the leveraged positions head for the exit at the same time causing reversal of
flows and depreciation of domestic currency. In the recent past, Reserve Bank had noticed
trends of volatile FPI flows in the short-term debt market which were impacting the foreign
exchange markets as well. In view of volatile FPI flows in the short term government
securities market, the Reserve Bank restricted FPI investments in dated government
securities earlier and corporate bonds recently to securities having residual maturity of three
year or above. The objective was two-fold (a) containing the interest rate and exchange rate
volatility and (b) developing the debt market by attracting long-term stable investments.
Contamination channel
28. In 2013, the Rupee had experienced huge quantum of volatility primarily due to the
external factors and fall in the risk appetite of the external investors. Following indications of
QE tapering by the Federal Reserve on May 22, 2013 and growing concerns about high
CAD, exchange rate depreciated sharply by about 15 per cent to Rs 63.75 in September
2013 over March 2013, touching an all-time low of Rs. 68.85 against dollar as on August 28,
2013. Subsequent policy actions undertaken both by the Reserve Bank and the Government,
however, augured well for Rupee stabilization as it gradually appreciated to Rs 60.10 by
endMarch 2014. For Q2 2014-15 as a whole the Rupee depreciated against the US dollar albeit
with some appreciating bias during the second week of August to first week of September
2014. During periods of higher volatility, Indian firms get affected by such sharp currency
movements by way of transaction, translation and economic exposures with serious
implications for their bottom line and future business capabilities.
29. Large scale reliance on borrowings abroad in foreign currency by Indian corporates
entails huge interest rate and exchange rate risks. The not-so-happy experience of
redemption of foreign currency convertible bonds (FCCBs) highlights the risk for the
corporates in issuing such foreign currency bonds on the uncertain premise of ever
increasing equity prices. Large unhedged forex exposure of corporate is not only a potential
threat to the balance sheets of the corporates but also to financial stability. Reserve Bank
has been highlighting the need for sound risk management culture of our corporates.
Reserve Bank has have been cautioning participants from taking too many bets in one
direction. It is essential for the banks to rigorously evaluate unhedged exposures of the
clients by adequately pricing in the risk premia. In the last few years, Indian corporates have
gone for establishment/acquisition of overseas companies, often at the cost of their capability
to meet the domestic business needs and without proper assessment of the risk-return
tradeoff. When global situation turned stressful, the viability of these overseas entities impact
domestic balance sheets. As a result, there have been disinvestments at large losses.
Central banks' actions & communication channel
30. Central bank actions in the developed economies have an impact on emerging markets.
These spillovers have been the subject of debates in academic and policy forums. Monetary
policy actions pass through interest rate, exchange rate, capital flow and the asset price
channels. The large scale asset purchase programme of the Federal Reserve depressed the
yields on US fixed income securities and the value of the US dollar until recently. QE
announcements by the Bank of Japan and the European Central Bank may also have similar
consequences though the magnitude could be different. The Swedish Riksbank's
announcement