Why credit rating matters for India?

The credit on India by international institutions affects India mainly through Indian corporate’s borrowing from overseas markets. The loans raised by Indian entities from foreign markets are known as External Commercial Borrowings.

When the Indian corporate are taking loans from international lenders through ECBs, the interest rate they have to pay is considerably influenced by credit ratings of rating agencies.

RBI in its ECB policy sets the maximum interest rate that can be paid on ECBs by Indian borrowers in terms of maturity of loans.

For example, at present, for loans above five-year maturity, the interest ceiling is six months LIBOR (London Interbank Offer Rate) plus 500 basis points. LIBOR is the standard interest rate in the London money market. The ceiling restriction implies that interest rate on ECB loan taken by an Indian borrower should be within LIBOR plus five percentages. If LIBOR is 4.5%, the maximum interest rate that can be given by an Indian borrower should be 9.5%.

Here, the floor is the average interest rate prevailing in global financial markets expressed in terms of LIBOR.

How much higher will be the interest rate for the borrower above the LIBOR?

It depends upon the creditworthiness of the Indian company as well as that of the economy.

Banks quote the interest on ECB in format of LIBOR + SPREAD. The difference between the basic LIBOR rate and the actual interest rate is called as credit spread (or SPREAD). It shows the higher interest rate a borrower should pay because of the risk involved. The credit spread depends upon the credibility of the borrower and the risk perception of the Indian economy. To measure the risk perception of the Indian borrower and the Indian economy, the foreign bank depends upon ratings given by the agencies. Higher the credit rating, lower will be the interest spread. This means that if credit rating of India goes down, the Indian borrower has to pay a higher spread.