Signs of stress in short-term dollar funding: RBI report

“Signs of stress in short-term dollar funding are also emerging,” it said.

“With the announcement of sanctions, the Forward Rate Agreement – Overnight Indexed Swap spread – a measure of how expensive or cheap it will be for banks to borrow in the interbank market relative to the risk-free rate – has widened, along with spreads on nonfinancial commercial paper,” said the Reserve Bank of India (RBI) report.

Since the beginning of the Russia-Ukraine war, the benchmark US Treasury yield surged 114 basis points, raising overall funding costs across the globe.

While international investors are seen seeking the safety of dollar-backed assets, a perceived dollar shortage has already started showing up in the currency forwards markets, with risk premiums dropping to decadal lows. If you are borrowing in dollars, you have to hedge (sell) it in the forwards pushing premiums down.

Reflecting the increase in risk aversion and impact of monetary policy tightening, corporate bond spreads in the US and emerging market economies have widened despite some moderation in June 2022, as valuations increasingly reflect a weak economic outlook, RBI FSR report said.

Around mid-June, the 10-year US Treasury gauge touched nearly 3.50 per cent, which later corrected to around 45 basis points. One basis point is 0.01%.

During the same period, the local benchmark paper fell about 13 basis points.

However, last year the US Treasury benchmark hovered broadly in the range of 1-1.5 per cent, luring many local companies to borrow overseas. Shriram Transport Finance and Indiabulls Housing Finance are among others with an outstanding debt to international investors.

“Another area of focus has been the build-up of debt among non-financial corporates, rising dollar-denominated debt in emerging market economies (EMEs) and the role of NBFIs,” the RBI report said.

“In sum, synchronised monetary tightening amidst heightened geopolitical tensions poses several financial stability risks,” it said.

Those risks include sell-offs of financial assets, rise in interest rates and market dislocations. Increasingly investors raise doubts over debt servicing capability.

Some Indian papers have yielded as much as 20 per cent in the offshore market in recent times.

“The likely erosion of risk appetite and tighter financial conditions could increase debt-servicing costs at a time when their ability to generate foreign exchange to service debt appears to be more constrained,” the FSR report said.

However, there is one silver lining. Even as the Chinese high-yield market is strewn with defaults, Indian high-yield papers appear to be a destination for global investors with higher risk appetites.