IMF Warns that Indian Companies Most at Risk with a Strong Dollar

The International Monetary Fund (IMF) recently conducted stress tests to model what effect an appreciation in the value of the US dollar would have on economies around the world. In a somewhat surprising turn, those who fared worst in a world with a more valuable dollar were not exporters of goods to America or countries dependent on US goods, but rather, Indian businesses.

The reason, according to the report, was a possible worsening of borrowing costs and earnings. Troubling news for Indian businesses, as the dollar has been on a sustained track of appreciation.

The International Monetary Fund (IMF) recently conducted stress tests to model what effect an appreciation in the value of the US dollar would have on economies around the world. In a somewhat surprising turn, those who fared worst in a world with a more valuable dollar were not exporters of goods to America or countries dependent on US goods, but rather, Indian businesses.

The reason, according to the report, was a possible worsening of borrowing costs and earnings. Troubling news for Indian businesses, as the dollar has been on a sustained track of appreciation.

The IMF report, titled “Spillovers from Dollar Appreciation,” contained other warnings for India. Specifically, it noted that at risk debt from India’s state-owned enterprises could increase significantly. Should the current dollar appreciation trend continue, along with Indian state enterprise borrowing habits, total at risk debt could top more than 5 percent of the country’s gross domestic product (GDP).

For the stress test, the IMF surveyed 4,797 Indian firms with total assets worth $1.5 trillion. The test assumed an increase in borrowing costs of 30%, with a corresponding decrease in earnings of 20%. It also assumed a depreciation of the Indian rupee of 30% against the US dollar.

Based on these assumptions, the IMF found that the median interest coverage ratio (ICR), which reveals how easily a company can pay interest on debt, showed a significant decline in most countries surveyed. This indicated a strong increase in borrowing costs and lost earnings. For India, in particular, the ICR (which is already below 1.5 percent), grew as high as five percent. Debt is seriously at risk at these levels.

According to the IMF, countries like India that have high forex leverage, or forex debt relative to total income, are more susceptible to exchange rate volatility. “Accordingly, in our stress test scenario, increases in forex leverage would be the largest in Brazil, Chile, India, Indonesia, and Malaysia,” the report said.

Unfortunately, banks in India do not have buffers sufficient to withstand losses from scenarios such as those in the IMF stress test, exacerbating the problem of ‘at risk debt’.

“Higher corporate default would erode banks’ asset quality, and the ability of banks to withstand losses will depend on the extent of available buffers. Assuming that the aftershock corporate debt-at-risk owed to banks were to default with a probability of 15% suggests that buffers comprising tier I capital and provisioning appear low in Bulgaria, Hungary, India, and Russia, when benchmarked against Basel III’s minimum capital requirement,” the IMF report said.

The report went on to say, “In some cases, bank buffers may be overstated due to lax recognition of doubtful assets and loan forbearance. In such instances, loan losses in a severe downturn and higher corporate default could overwhelm what were thought to be adequate levels of equity capital.”

This latest warning is not the first for India. In April 2014, the IMF warned that high debt in some Indian companies could pose a risk to the country’s economic stability. Indian companies with debt-to-equity ratios of more than three (the highest degree of leverage in the Asia-Pacific region) accounts for one-third of India’s corporate debt.