INDIA'S EXTERNAL DEBT: DOLLAR-DENOMINATED OR RUPEE-DENOMINATED

By: R. vashistha

26^th oct, 2015.

Our external debts could be dollar-denominated or Rupee denominated.If our external debts are in dollars, we receive debts in dollars and we need to pay interest and principal-sums in dollars. if our external debts are in Rupee we receive in Rupee and pay in Rupee.

Dollar- denominated debts are riskier than Rupee-denominated debts. Let us understand why this is so.

Suppose we take one year loan in dollars-terms from U.S at 10% of interest rate.Loan amount is $ 100 and prevailing exchange rate is RS.65 per dollar( $1= RS.65). At the end of the year we need to pay $100 as principal + $10 as interest =$110. At prevailing exchange rate it would cost us 65 multiplied with 110 = RS. 7150.

If in a year India's currency depreciates against U.S dollar and new exchange rate becomes RS.70 per dollar( $1=RS.70), we would be at disadvantage. To settle our debt in new situation we would shell out RS.7700( 70 times 110). This amount is more than before when exchange rate was RS. 65 a dollar. Depreciation of currency makes our external debt costlier. This is called exchange rate risk of foreign debt.

However, such risk is not involved in Rupee-denominated debt. In fact, in such type of loan exchange rate risk is diverted to creditors. Let us understand how this becomes possible.

Suppose we take RS. 100 as  loan from U.S in Rupee at 10% of annual interest rate. And, exchange rate is RS.65  dollar. At the end of the year, we would pay RS.110. Even if Rupee depreciates to RS.70 per dollar we need to pay only RS. 110. So, if our  external debts are Rupee-denominated , there is no risk of currency depreciation.

The risk of our currency depreciation has been shifted to U.S. which is at disadvantage if Indian Rupee depreciates from 65 to 70 per dollar.

When exchange rate is 65 per dollar, receiving RS. 110 from India by U.S means receiving $ 1.69 ( 110 divided by 65). When exchange rate is 70 per dollar, receiving RS. 110 from India by U.S means receiving $ 1.57 (110 divided by 70). Clearly, The U.S is at a loss due to depreciation of currency.

India’s 60 % of external debt is Dollar-denominated and only 24% of debt is Rupee- denominate.