Easy Money, Hard Lessons

The Reserve Bank of India’s new external commercial borrowing framework is being billed as a bold step towards deepening India’s financial integration. It seek to expand the list of eligible borrowers, removes cost ceilings, and simplifies end-use conditions. To many in corporate India, it signalled a long-awaited liberation from procedural constraints. Yet beneath this appearance of modernisation lies a familiar vulnerability: the persistent underestimation of foreign currency risk.

The outstanding stock of ECBs has climbed to about $260 billion, up from $180 billion a decade ago, now accounting for nearly one-fifth of annual capital inflows. The message is clear, cheap offshore money remains irresistible. But the cost advantage of foreign borrowing can vanish overnight when the rupee slides and hedges are thin.

According to Financial Stability Report of December 2024 as of September 2024, roughly 34% of total ECB exposure, amounting to $65 billion, was unhedged. Even a small rupee depreciation could inflate repayment obligations by significantly higher proportions, directly hitting balance sheets and credit quality. The comforting notion that companies have “natural hedges” through exports is overstated, particularly for infrastructure, manufacturing, and services firms with largely domestic revenues.

 Proposed RBI’s ECB Relaxations

 While the above flexibilities are meant to promote efficient capital allocation, it also allows companies to borrow offshore for rupee-based activities, effectively taking on unhedged foreign currency risk without offsetting cash flows.

Hedging costs are part of the story, but not the whole of it.

Liquidity constraints, documentation complexity, and the high forward premium make full hedging unattractive for smaller borrowers. Many prefer to gamble on currency stability or engage in sub-optimal hedging or even no hedging at all, rather than pay the upfront cost of protection. That logic works, until it doesn’t.

India’s last major episode of corporate foreign debt stress, in 2013, was triggered by the same complacency. When the rupee weakened sharply, hedging coverage evaporated, and refinancing windows shut. The present geopolitical and tariff issues have led to significant depreciation of rupees with concomitant volatilities which assumes increased significance and the need to hedge their exposures. There is sufficient breadth of permitted derivative contracts such as forward contracts, currency swaps, cross currency interest rate swaps, enabling participants to hedge their currency exposures. RBI requires mandatory underlying exposure requirements beyond a threshold limit for certain derivative contracts. However the proposed new relaxations are expected to significantly increase the volume of foreign borrowings by Indian corporates, thereby heightening demand for hedging instruments and the need to ensure more liquidity in the market. For the RBI, the challenge is not to roll back liberalisation but to reframe it.

True financial maturity lies not in the freedom to borrow abroad, but in the discipline to hedge intelligently and disclose transparently. Mandatory stress tests, public reporting of unhedged exposures, and stronger supervision of derivative practices would send the right signal.

At a time when the rupee faces structural pressures, from a widening trade gap to persistent capital outflows, India can ill afford a currency-induced corporate shock. The ECB boom is often presented as a vote of global confidence in Indian companies. It is also a test of their risk culture. The selection among hedging instruments depends on multiple factors: the company's risk appetite, cost considerations, treasury capabilities, accounting treatment preferences, and the correlation between hedging costs and business economics. Another challenge is about understanding the ECB guidelines including usage of correct hedging instruments, payoffs, being uptodate with the recent guidelines. All the stakeholders should also be aware of unsubstantiated claims about mis-selling of structured products and act accordingly depending upon their roles and responsibilities.

RBI’s revised framework has opened the global tap. Whether that becomes a source of growth or a source of contagion will depend less on regulatory design and more on corporate discipline. Cheap foreign money has a way of flattering balance sheets before it punishes them. India has learned that lesson before. It would be unwise to forget it now.