Money & Finance

Foreign currency borrowing by Indian firms: What do we know?

  • Blog Post Date 09 November, 2015
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Ila Patnaik

National Institute of Public Finance and Policy

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Ajay Shah

National Institute of Public Finance and Policy

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Nirvikar Singh

University of California, Santa Cruz

As foreign currency borrowing by Indian firms has been increasing, concerns have surfaced about rising associated risks. Hence, recent policy changes seeking to make the regulatory regime simpler and more transparent are timely. This column addresses several important questions regarding foreign currency borrowing of Indian firms, the answers to which can provide a firmer basis for ongoing policy formulation.

As is the case with many other aspects of Indian economic policy, the regulatory regime with respect to foreign borrowing by Indian firms has been complex and discretionary. This is changing slowly, with recent moves to loosen restrictions on rupee-denominated borrowing (which has no associated exchange-rate risk), and to create clear and transparent standards for risk management, rather than relying too heavily on pre-emptive controls. These changes, and the overall policy attention, are timely, because foreign currency borrowing (FCB) by Indian firms has been increasing, as it has for other emerging market economies, and concerns have surfaced about rising risks1.

In recent research on FCB by Indian firms, we seek to address several important questions, the answers to which can provide a firmer basis for ongoing policy formulation with respect to FCB, in the context of concerns about systemic risk (Patnaik, Shah and Singh 2015). First, which firms use FCB? Second, how do they perform subsequent to that borrowing? Third, what risks are associated with FCB?

Which firms borrow in foreign currency?

Examining balance sheet and income statement data for 2002-2013 from the Prowess database of the Centre for Monitoring Indian Economy Pvt. Ltd. (CMIE) on thousands of Indian firms (10,869 firms are observed in 2011-12), reveals that FCB is, and has been, heavily skewed towards larger firms (in terms of sales and total assets). Almost all FCB measured in the dataset is concentrated in the top quartile of firms (firms that have above Rs. 50 million in sales), and each year the 30 largest firms by FCB totals in the sample account for about two-thirds of FCB (the smallest of these firms had about Rs. 12 billion in sales in 2013).

What are the impacts on firm performance?

On the second question, in order to examine impacts of FCB on firms using this channel, we create matched pairs of firms based on close similarity of all relevant characteristics, except for whether they use FCB or not. In a given year, the average of FCB to total borrowing for the firms that use FCB ranges from about 26-44%. We find mostly small positive (but often negligible) effects on the subsequent sales, asset, and employment growth of firms that used FCB, relative to their match partners. Since the matching algorithm did not find close comparators for the largest few firms, which account for almost two-thirds of FCB in our dataset, we also examine impacts on the same performance measures for those firms through an alternative technique. The results obtained in this way are broadly similar to the matching technique results.

What are the risks?

To examine the possible risk consequences of FCB, we first calculate interest coverage ratios2 for individual firms. These are used in finance to provide a rule-of-thumb measure for possibilities of default on debt because of inadequate cash flows. In our calculations, we adjust for exchange-rate risk, thereby obtaining a combined indicator of risk due to FCB (the risk due to exchange-rate fluctuation) and overall risk of default on borrowing due to leverage3. A particular concern is whether firms that face high default risks associated with FCB are significant enough to potentially cause problems for the rest of the economy if they run into liquidity problems – a situation of systemic risk. While we do not find systemic problems overall, there is considerable variation across individual firms, including among the small set of large firms that borrow the most.

To directly examine the risks associated with currency mismatch (differences between the currencies in which money is earned versus those in which payments must be made), we introduce the idea of natural hedging - which refers to a situation in which revenues or costs are affected by exchange-rate fluctuations in ways that neutralise the impact of those fluctuations on debt obligations - and show how it could be related to exporting, as well as to tradability and import parity pricing4 , even for non-exporting firms. We find that firms that used FCB were in general not naturally hedged at all, suggesting an inefficiency in the set of firms availing FCB, probably due to regulatory constraints such as interest rate limits, sectoral limits, and restrictions on participating in derivative markets, as well as discretionary controls on FCB.


Overall, our empirical analysis of firm-level data suggests mild positive benefits and limited risks from FCB, to date. Our main finding is that the bulk of FCB is availed by larger firms, and, in particular, firms with natural hedges (and therefore, some built-in protection against the exchange-rate risk of FCB) have tended to be excluded from even attempting access to FCB by the existing regulatory regime.

As the global financial crisis revealed, market judgments on individual firm risks are not sufficient to ensure optimal management of systemic risks. The problem of overall mitigation of systemic risks is a complicated one. However, for the specific case of currency mismatch associated with FCB by individual Indian firms, greater exchange-rate flexibility and large and liquid currency derivative markets5 offer a relatively simple policy framework for the long term. Under these broader policy conditions, the chance of systemic risk arising from a large number of large firms undertaking unhedged currency exposure is likely to be low. This view does not contradict the position, supported by our research, that a minimum hedging requirement can be a useful transitional policy measure.


  1. See Chui, Fender and Sushko (2014), which represents research coming out of the Bank for International Settlements, a major international body concerned with aspects of macroprudential policies and managing international financial risks.
  2. Interest coverage ratio is the ratio of a firm’s earnings before interest and taxes in a particular period to the interest that the firm must pay on its debt during the same period.
  3. Leverage refers to the amount of debt a firm has in relation to its equity capital.
  4. This term captures the idea that, if a good is tradeable across international borders, its price will tend to be the world price, so that even domestic purchases will be at prices that have parity with import prices.
  5. A currency derivative is a financial instrument whose value is based on the performance of the underlying currency. Large and liquid currency derivative markets make it less costly, and more practical, for firms to explicitly hedge their exchange-rate risk that might arise from FCB or other sources.

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