In today's Finshots we see why India is obsessed with Yen-denominated loans these days

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Last month, the Reserve Bank of India made a quick mention of India’s external debt. This debt includes all the money borrowed by Indian businesses and the government in foreign currencies from outside the country, including foreign banks, governments, or international financial institutions.

The figure stood at $663.8 billion– a gargantuan figure, no doubt. But nothing too worrying. And as one may expect, more than half of this debt was denominated in US dollars.

If you were not expecting this, let us first explain why US dollars remain a hot commodity in India.

The US dollar is the most commonly used currency in international trade and finance. This global trust in the dollar lends stability and predictability to transactions. For Indian businesses and the government, borrowing in US dollars allows them to engage more easily in global trade, as many international contracts are priced in dollars. Additionally, loans in US dollars often come with lower interest rates compared to those in local currency, making them more attractive for financing large projects.

So this is why the dominance of the greenback in India’s external debt isn’t out of the ordinary.

Sidenote: A “greenback” is a colloquial term for U.S. paper dollars, originating from the mid-1860s due to their green ink print.

But then, here is something really interesting.

As reported by Livemint, in December 2023, the Union government secured a hefty $250 million from the ADB (Asian Development Bank) for the Delhi-Meerut Regional Rapid Transit System project. Similarly, the Tamil Nadu government scored big in April 2024 with a $300 million loan from the World Bank to upgrade its urban water and sanitation services.

Major companies like JSW Steel, REC (Rural Electrification Corporation), PFC (Power Finance Corporation), and HUDCO (Housing and Urban Development Corporation) collectively snagged upwards of ₹11,000 crore in debt over the past year.

But all these projects had one common theme. The debt was denominated in Japanese Yen instead of US dollars. This means that the money is borrowed, valued and repaid in Yen.

And to understand this shift, it’s essential to take a look at Japan’s economic history.

In the 1980s, Japan’s economy was booming. Record low-interest rates got real estate and stock market valuations soaring. People took on large amounts of debt to buy property that they expected would appreciate in value. Unfortunately, too much optimism can be a bad thing sometimes.

Because come 1990, the Japanese government began to realise that this was unsustainable. The bubble had to pop. So they raised interest rates, and boom, there was pandemonium everywhere. The stock markets crashed and a debt crisis took shape as borrowers failed to meet their payment obligations (because of the high interest rates). Banks grappled with unpaid loans. Consumer spending plummeted. Wages stagnated. People emigrated. And as spending decreased, prices of goods and services dropped down to unviable levels. The whole thing was a gloomy mess. And then it got worse, because of an earthquake and Tsunami in 2011.

Then in 2012, Japan’s Prime Minister Shinzō Abe was re-elected.

He immediately launched a series of reforms that were dubbed ‘Abenomics’.

At the time, one of the principal objectives of the government was to work with the country’s central bank to ensure the free flow of credit. And in a bid to make money more accessible, the Bank of Japan cut interest rates to zero. Technically this happened much before Abe came into power. The only difference — During Abe’s tenure, the Bank of Japan took it a step further. On top of it, they also initiated a program to print new money. Most people call it quantitative easing. We call it what it is — Printing money.

In simple words, he asked Japan’s central bank to print money — between 60–70 trillion Yen. With more money in circulation, the Yen lost its value.

Also, due to Japan's ageing population and low birth rates, people saved more and spent less. This meant banks had plenty of money to lend at low costs. While these low borrowing costs were meant to boost spending, they also made Yen-denominated investments less appealing compared to higher-yield options abroad. Investors seeking better returns moved their money out of Japan, decreasing demand for the Yen and causing it to weaken against other currencies.

This may seem bad for the currency, but at the same time, these measures were meant to boost the Japanese economy.

And while the growth boost never came, the Yen kept losing its value.

Between 2021 and 2024  the Yen lost at least one-third of its value against the US dollar. By mid-2024, the Yen had hit a 34-year low against the dollar, reflecting a significant shift in its value.

With this, we can wrap up our quick detour and get back to the main story–India’s external debt situation.

When it comes to raising funds, both governments and corporations meticulously evaluate the total cost of borrowing. If they can borrow at low interest rates and the foreign currency keeps losing its value, that’s an approachable currency. And Yen is very very approachable right now.

For starters, the Yen has taken a nosedive against the Indian rupee in recent months. For context, the rupee has shot up by a whopping 18% compared to the Yen since the beginning of 2023.

So imagine this: An Indian company secures a 1 billion Yen loan at the start of 2023, costing them Rs 67 crores per the Rupee-Yen exchange rate prevailing at that time. But now, with the rupee gaining ground against the Yen and the Yen trading at just Rs 0.55, the company can repay the same loan for only Rs 55 crores, saving them Rs 12 crores.

Second, the interest rates are very very low–often less than 1%. In contrast, a USD loan with an assumed interest rate of 5% would result in much higher annual interest payments. So naturally Japanese loans are more attractive.

Put all this together and you can see why everybody’s borrowing in Yen.

So why doesn’t the whole country borrow money in Yen and benefit from the low interest rates?

Well, there’s a teeny tiny problem with this scheme that we haven’t discussed yet. While the interest rate on Yen denominated loans may look attractive, you have to consider unfavourable currency fluctuations before you start borrowing money from Japanese banks.

Let us give you an example. In the early 1980s banks in Australia had a similar brain wave. Loans in Australia were expensive and businesses were reluctant to borrow at such exorbitant rates. So to make borrowing more accessible, local banks started offering loans denominated in Swiss francs to small businesses and farmers. This arrangement initially seemed attractive due to the significantly lower interest rates compared to those available in Australia at the time.

Swiss loans were cheaper.

However, the key risk with these loans was that they were in a foreign currency (Swiss francs) while the borrowers' incomes were in Australian dollars. When the exchange rate between the Australian dollar and the Swiss franc shifted unfavoruably, the value of the Swiss franc increased relative to the Australian dollar. This change meant that the amount of Australian dollars needed to repay the same amount of Swiss francs increased dramatically, leading to substantially higher repayment costs for the borrowers.

So now despite the interest rate being low, farmers still had to cough up increasing amounts of Australian dollars to keep repaying the loan. Many borrowers found themselves financially "underwater" because the amount they owed in Swiss francs was now far greater in terms of their home currency than when they had taken out the loans. The situation was exacerbated by allegations that the banks had not fully informed the borrowers about the potential risks of currency fluctuations, which could—and did—lead to severe financial distress for those who had taken the loans.

This became known as the Swiss loans affair.

So as you can see, this scheme can be incredibly attractive so long as the Indian currency keeps appreciating against the Yen. In the event that we see the Yen appreciate against the Indian rupee, you can bet that both the government and Indian businesses will begin reevaluating these loans very quickly.

Until then…

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