Japan interest rate hike, US recession fears may make offshore borrowing difficult for Indian corporates

As a result, India's benchmark Sensex and Nifty indices slipped almost 3 percent each on August 5, as weak global cues fuelled panic selling among investors, resulting in a broad-based selloff.

These developments come at a time when several Indian companies had started tapping the offshore debt market this year, following very little activity in the last two years on account of the US Federal Reserve raising interest rates with the outbreak of hostilities between Russia and Ukraine, and joining the global fight against inflation.

Several Indian companies including the country’s biggest lender State Bank of India and other non-bank lenders such as Indiabulls Housing Finance, Shriram Finance and Muthoot Finance have raised debt overseas this year. State-owned REC raised around $500 million through yen-denominated bonds.

Experts believe that the events are likely to lead to investors becoming more risk-averse and thus seeking higher returns, especially for longer-term debt paper.

“The change in Fed’s tone and re-ignition of recession narrative comes at a time when BoJ (Bank of Japan) is delivering its most hawkish signal in decades and that after this week's hike, the BoJ would continue raising the policy rate gradually. We note while the Japanese yield curve is one of the few globally that still offers an attractive carry, Japan also remains the largest holder of USTs (US Treasuries). Japan's Life insurers are one of the biggest holders of non-Japanese govt bonds and their estimated hedge ratio sits close to 50%,” Madhavi Arora, Lead Economist, Emkay Global Financial Services, said in a note.

Arora added that a combination of higher long-term yields in Japan, an unattractive hedge ratio for Japanese companies on overseas investments and a stronger yen, driven by other factors more than a hawkish BOJ, will cause a repatriation of capital into Japan.

“This may cause the global bond term premia to rise,” she said.

A term premium is the added compensation that bond investors expect for the uncertainties and risks associated with holding longer-term debt.

Economists added that Japan's interest rate hike and the subsequent unwinding of the yen carry trade, combined with a recessionary phase in the US in the near term, could create a liquidity crunch that could make offshore debt investors wary of emerging market exposure and make offshore fundraising dearer for Indian companies.

“The bigger concern though is the impact of the rate hike on the yen carry trade and the leverage built on top of it and how that impacts market liquidity. Coupled with an adjustment in the US economy—a recession phase—there could be a risk of liquidity crunch, which could lead to higher borrowing costs for corporates,” said Suvodeep Rakshit, chief economist, Kotak Institutional Equities.

He added that the interest rate hike (in Japan) won't be an immediate concern for most state-backed infrastructure-related loans in India as these are long-duration loans with fixed interest rates, but it could be a challenge for shorter-term loans where redemptions/repayments are coming up, as refinancing could become expensive.

To be sure, some experts feel that despite the negative news affecting the global markets lately, an expedited rate cut action by the US Fed could reverse the fears and also increase liquidity flows.

“Some of the data points coming out of the US are not as worrying and thus the recession fears may be overblown. If the Fed acts and cuts rates quickly, then that may even send some more liquidity towards markets like India,” said a Mumbai-based investment banker.