India Inc. wary as Japan tinkers with interest rates

The Japanese central bank’s decision last week to raise its benchmark interest rate from 0-0.1% to 0.25%—only the second increase in 17 years since ending its loose monetary policy in March—sent shockwaves through global financial markets, including India.

The rate hike led to yen carry trade unwinds, boosting the yen against the dollar and sinking stocks.

In a carry trade, investors borrow money in a currency with a low interest rate (Japanese yen, until last week) and invest in another currency offering higher returns, pocketing the difference.

Carry trades in yen have been popular in emerging markets in the past as volatility was low, with investors betting that Japanese interest rates would stay at rock bottom.

The latest shift in the Bank of Japan’s monetary stance could end that advantage, according to some analysts.

To be sure, key Asian indices, especially in Japan, which were pushed into bear market territory on Monday, bounced back on Tuesday as they clawed back some of the losses.

On the other hand, Indian benchmark indices Sensex and Nifty, which fell 2.7% on Monday, declined by a further 0.2% on Tuesday.

The yen, meanwhile, snapped a five-day rally versus the dollar on Tuesday, though JPMorgan said the carry trade unwind isn’t done yet as the yen remains one of the most undervalued currencies.

The impact on India

So how will the shift in BoJ’s monetary policy affect India?

India’s external debt at the end of March stood at $663.8 billion, of which yen-denominated loans were at 5.8%, according to latest Reserve Bank of India data released on 25 June.

The country is one of the biggest recipients of cheap loans from the Japanese Official Development Assistance, which have mostly funded India’s infrastructure push, especially in building the Delhi Metro and the first bullet train in the country.

Any increase in the interest rates on such loans may lead to a surge in costs, which may drain resources and put projects in jeopardy.

Further hikes in interest rates, which analysts have said could be a possibility, may also raise the debt servicing costs of those Indian companies that have raised long-term loans in yen when the rates were near zero.

A surging yen–it’s up 8% against the dollar in a week– will lead to costlier import costs from Japan.

The Japanese yen had seen a decline against the Indian rupee. An 18% increase in the rupee’s value against the yen since early 2023 had made yen-denominated loans even more appealing.

Large companies as well as state governments were turning to the yen over the US dollar to raise overseas debt, Mint had reported last month.

JSW Steel Ltd, Rural Electrification Corp. (REC), Power Finance Corp. (PFC), and Housing and Urban Development Corp. (HUDCO) have cumulatively raised yen-denominated debt upwards of ¥200 billion (about ₹11,000 crore) in 11 months, the Mint report said, citing company disclosures.

These include loans as well as bonds, with the largest among these being REC, which has raised ¥153 billion (about ₹8,390 crore) since January over three different debt facilities.

The interest rates on yen loans are low, often below 1%, when compared with a 5% rate on dollar loans.

Indian entities are not alone in leveraging the benefits of yen-based debt.

Bangladesh this month raised about $700 million from the World Bank in yen to reduce the interest cost, according to a report in The Business Standard, a Bangladesh-based daily.

BoJ governor Kazuo Ueda last week said the central bank raised rates based on economic and inflation data, adding that rates would keep increasing.

The worst equity market turmoil in decades following the move now has some analysts thinking that BoJ may have acted a bit too early, suggesting a more tempered approach going forward.