The forex story for the country in the last couple of years has been a dream with the onus shifting to the monetary authority to balance increasing liquidity with rupee appreciation. The gathering of dollars essentially from the investment route has prefaced all such stories. While this cannot be contested, there is something else happening in the background which could be a concern that needs to be tracked carefully even though there are presently no signs of any problems. The issue in question is India's external debt.

The Economic Survey has highlighted the sudden surge in external debt which rose from $ 84 billion in 1991 to $ 101 in 2001, registering an average annual increase of $ 1.7 bn. The number was higher at around $ 15 bn per annum in the next six and half years with external debt rising to $ 190 bn by September 2007. This really means that while foreign investment has been flowing in large numbers, the debt component has also been rising. Forex reserves have been rising at around $ 33 bn a year in this period, with acceleration in the last 18 months. 

INDIA'S EXTERNAL DEBT ($ BN)
Year (ending March)	Total debt	Commercial borrowings	NRI deposits	Short term debt
2002	98.80	23.30	17.10	2.70
2003	104.90	22.50	23.10	4.70
2004	111.60	22.00	31.20	4.40
2005	132.90	26.40	32.70	17.70
2006	138.10	26.40	36.30	19.60
2007	169.60	41.70	41.20	26.20
Sept 2007	190.50	51.80	43.60	30.80
Source: Economic Survey 2007-08

The table shows that the turning point has actually been 2006-07 when external debt ballooned significantly. In 2006-07, external debt rose by roughly $ 31 bn while the FDI and FII inflows were $ 23 bn and $ 7 bn respectively. This trend persists in the first half of 2007-08, where foreign investment was around $ 21-22 bn while debt rose by $ 21 bn. This really means that there was an almost 1:1 incremental debt-equity ratio being registered during these two periods.  In fact, while debt has increased by over $ 50 bn in the last eighteen months, our overall forex reserves have risen by $ 85 bn.

The rise in external debt the last 18 months ending September 2007 has been really enormous at over $ 50 bn. The increase has come from three sources, two of which need attention. The first is the rise in the commercial borrowings which have almost doubled in the last 18 months. There are two reasons for this. The first is that Indian companies have been scouting the global markets for funds which are available at a lower cost. It may be noted here that interest rates in India have been rising in the last couple for years while the Fed and ECB have been driving down the rates gradually in the last year or so.

This makes it easier for the better rated companies to access the Euro markets for funds. With the interest rate (PLR) differential being between 400-500 bps and adding another 100-150 bps as risk premium and 50 bps for exchange risk (this is low as one expects the rupee to strengthen further) there would still be a net differential of 100-150 bps in interest  rates.

The other factor is the growing evidence of carry trade where funds are being borrowed at lower interest rates and on-lent at higher rate with again the exchange rate risk being assumed to be minimal. While this amount cannot be quantified, this could be another reason for higher commercial borrowings. Bank borrowings constitute around 60-70 per cent  of these commercial borrowings while the rest are securitized borrowings.

The other serious concern is the rise in short term debt. The increase by $ 10-11 bn in the last 8 months is quite high. It may be recollected that high short-term debt was one of the reasons why the Asian crisis originated and spread quite catastrophically across that part of the continent. This is the kind of funds which could take flight in times of a crisis. We had prided ourselves in maintaining short term debt at a low level of around 4 per centof total debt. Today at 16per cent, it is a worry.

The third factor driving debt has been the NRIs, where interest rate differentials could be the factor driving them along with the India Shining story. This has been somewhat fickle in the past where reduction in interest rate differentials could cause inflows to slowdown.

If these two components, i.e. NRI deposits and short term debt are considered to be vulnerable flows, as they are reversible, then the total quantity would be around $ 75 bn.

Add to this another $ 75 bn of FII inflows which today could be valued at between 2-3 times given that these are the absolute investment inflows made cumulatively since 1992 whose value would have risen with the stock markets. In fact, if the FIIs were to withdraw, the amount would be a multiple of this $75 bn.

Add to this,  four months of prudential imports cover, of around $80 bn. Without taking into account the capital appreciation of our FII inflows, the total vulnerable capital flows would be around $ 230bn. Now, when this number is juxtaposed with the total forex reserves of nearly $ 300 which we have today, the comfort level drops.

The writer is Chief Economist, NCDEX limited. Views expressed are personal.