As per the latest reported data (7 January 2022), RBI was holding a total of US$632.7bn in non INR assets. This includes US$569.3bn foreign currencies, US$39bn gold, US$19.1bn SDRs and US$5.2 reserve position in the IMF.

Considering our emotional attachment to gold, I would like to categorize it as emergency reserve only. So effectively, RBI has US$569.3bn worth of foreign currency to meet the regular demand.

Considering an expected trade deficit of US$200-220bn for FY23, we appear adequately covered for monetary tightening by global central bankers and consequent unwind of USD carry trade potentially leading to FPI outflows.

Assuming, that the global central bank monetary tightening is able to reign the runaway inflation, and India inflation remains at midpoint of RBI target range, we may end up with 2-2.5% INR depreciation for the year, implying end FY23 exchange rate (INR/USD) of 75 to 75.5; of course, not a matter of much concern.

Some recent news headlines have drawn attention to the impending redemption of US$256bn foreign debt in 2022 (see here). This is ~44% of the total last reported US$596bn external debt (September 2021). Some reports have presented the situation as challenging, given the tightening monetary conditions overseas.

Some analysts have drawn attention to the fact that the pace of forex reserve accretion has slowed down in 2021. RBI added US$124bn to its kitty in 2020, while 2021 addition was only US$48bn. Material outflows on account of net negative FPI flows resulting in larger than presently anticipated current account deficit could potentially result in a mini crisis; though not to the tune of what we saw in 2013.

In this context the following points are noteworthy:

(a)   Private commercial borrowings (ECBs) are largest component of this debt with ~37% share; followed by NRI deposits ~25% and short term trade credit (~17%).

(b)   Only about 52% of India’s external debt is denominated in USD. Over ~33 is actually INR denominated debt. Rest is ~6% (JPY); ~3.5% EUR) and ~4.5% (SDR).

(c)    Non-Financial companies owe ~41% of India’s foreign debt. This includes top private and public sector corporations. Deposit taking lenders owe ~28%; government ~19% and other financial corporations owe ~8%. About 5% is intercompany lending.

(d)   Of the total debt due for repayment in 2022, about 40% is owed by deposit taking lenders (Banks and NBFCs). Most of this is long term debt maturing in 2022. Obviously, these borrowers would have made adequate arrangements to repay/renew this debt. About 50% is owed by other corporations and mostly comprises of short term trade credit that mostly keeps on renewing automatically.  (See details here)

I would also like to draw attention towards the following recent headlines:

Ø  RIL raises US$4bn in 10 to 40yr debt at coupon rate ranging between 2.8% to 3.8%. The offering was oversubscribed 3 times. Out of this US$1.2bn will be used to repay the debt becoming due for repayment in 2022. (see here)

Ø  Including RIL, a total of US$6bn debt has been raised in first two weeks of January alone. Corporations like SBI, JSW Infra, Shriram Transport Finance, India Clean Energy etc. have been able to reduce their borrowing cost by 30-35bps in these renewals. (see here)

Ø  The global arm of UPL Limited has raised US$700m to repay its older debt at 35bps lower cost. The proceeds of the loans will be used to repay part of the debt it had raised to fund the $4.2-billion acquisition of Arysta Life Sciences in 2019. The company has redeemed US$410m debt recently and plans to repay more in 4QFY22. (see here)

Obviously, raising money overseas may not be a challenge for corporate India. Reduction or complete elimination of QE money may not be a significant credit or currency event for Indian economy in 2022. Insofar as the lower addition to new forex reserve by RBI in 2021 is concerned, it may be due to change in RBI stance toward liquidity (buying USD from market involves increasing INR liquidity). Net FPI outflows were not much as secondary market selling was mostly offset by primary market buying.

The real potential challenge for Indian Economy and INR could come from the following:

1.    The Central Bankers fail in reining the inflation despite monetary tightening, as the inflation presently is mostly a supply driven phenomenon. India’s crude cost import cost crossing US$100/bn could put a serious pressure on current account.

2.    Persistent erratic weathers across the globe could further deteriorate the food supply situation leading to further rise in global food prices.

3.    A major geopolitical even could cause temporary supply restriction further worsening the present logjam at major ports hampering exports and exacerbating supply challenges.

4.    Outbound FDI outpacing the incoming FDI, as more Indian businesses look to establish local presence in foreign jurisdiction to counter hyper nationalism or continued mobility restrictions.

In its latest Annual General Meeting, Mr. Mukesh Ambani, Chairman of Reliance Industries announced an ambitious plan for setting up new energy business. The plan includes building four Giga factories to produce photovoltaic modules, advanced energy storage batteries, electrolyzers for the production of green hydrogen; and fuel cells for converting hydrogen into motive and stationary power.

The announcement has added more energy to the already popular trade in alternative and new energy. Even though the media narrative has been more focused on the renewable energy and electric mobility, from stock market perspective, the most popular trade has perhaps been in the sugar manufacturers who have set up decent ethanol manufacturing capacities in past one decade or so.

The Government of India had announced an ambitious ethanol blending program (EBP) in 2018, through a National Policy on Biofuels-2018 (NPB-2018). The program included interest rate subvention for setting up molasses and grain-based distilleries (DFPD). The Bureau of India Standards (BIS) prescribed standards for E5 (95% Petrol and 5% Ethanol), E10 and E20 blends of ethanol and petrol. Initially the target was set to achieve E20 stage by 2030 in line with the Sustainable Development Goals (SDGs). However recently, the E20 target date has now been advanced to April 2023.

NBP-2018 in perspective

To put the NBP-2018 in perspective—

·         At the end of FY21, the ethanol production capacity in India was 426 crore liters from molasses-based distilleries, and 258 cr liters from grain based distilleries.

·         To Achieve E20 target by 2025, India would need a total of 1500cr liters capacity to cater to the blending demand and other demands, e.g., liquor, sanitizer etc.

·         It is estimated that the molasses based capacity shall get increased to 760cr liters (from present 426cr liters) and grain based distillery capacity shall get enhanced from the present 258cr liters to 740cr liters by 2025.

Obviously, the larger focus would be on grain based distilleries rather than sugar based distilleries. To produce the required ethanol to E20 target, total 6 million MT of sugar and 16.5million MT of grains would need to be sacrificed.

·         Technically E20 target could be achieved without any significant modification in the vehicle design. However, when using E20, there is an estimated loss of 6-7% fuel efficiency for 4 wheelers which are originally designed for E0 and calibrated for E10, 3-4% for 2 wheelers designed for E0 and calibrated for E10 and 1-2% for 4 wheelers designed for E10 and calibrated for E20. However, as per SIAM, the efficiency loss could be further reduced through some modifications in engines (hardware and tuning). SIAM has assured that E20 material compliant and E10 engine tuned vehicles may be rolled out all across the country from April 2023.

·         The present transportation fuel consumption mix in India is 65% Diesel, 28% Petrol and 7% Jet Fuel. NBP-2018 addresses only the petrol blending.

·         The dispensing pump infrastructure would need to be developed to enable dispensing of E0, E10, E20 and E20+ separately. Presently, only a handful of fuel stations are equipped to dispense the variety of blends. Besides, the entire supply chain and logistics of OMCs needs to be augmented to store, handle and dispense different blends.

Objectives of NBP-2018

From various discussion papers and policy documents, it is not clear what is the primary objective of the EBP. A plain reading of NPB-2018 would suggest that the current account deficit is the primary driver of EBP.

As per “The Roadmap for Ethanol Blending in India 2020-2025”, published by NITU Aayog, “India imports 85% of its oil requirement. The Indian economy is expected to grow steadily despite temporary setbacks due to the COVID pandemic. This would result in a further increase of vehicular population which in turn will increase the demand for transportation fuels. Domestic biofuels provide a strategic opportunity to the country, as they reduce the nation’s dependence on imported fossil fuels.” The positive impact on environment is mentioned as an incidental benefit.

However, at places energy security and commitment to emission reduction under SGDs are also mentioned as primary objectives of EBP.

It is pertinent to note the following in this context:

·         EBP, in its present form addresses only 28% of India’s fuel mix, i.e., petrol used as transportation fuel. It does not address the more polluting diesel which forms 2/3^rd of India’s transportation fuel mix.

·         To achieve E20 target, about 50% of the ethanol requirements would be met through sugar based ethanol. Sugarcane is highly water intensive crop. In that sense, it would not be environment friendly to increase the acreage of sugarcane crop.

Secondly, sugarcane is not an all India crop. Most of the sugar cane is produced in three states, viz., UP, Maharashtra and Kanataka. Tamil Nadu, Andhra Pradesh, and Gujarat, and some other states are minor contributors to sugarcane crop. Naturally, most of the ethanol producing capacity is located in UP, Maharashtra and Karnataka. Transporting this ethanol to various locations for blending and storing it there, could be a significant energy consuming effort in itself. Storage is even more critical since sugar is a seasonal industry. Most of the molasses is produced between November and March, while the consumption would take place 365days in a year.

The role of grain based distilleries therefore could be more important than the sugar based distilleries over a longer period. This brings me to the other area of reforms which is work in progress.

As per the 01 May 2021 press release of the Press Information Bureau (PIB), “With the vision to boost agricultural economy, to reduce dependence on imported fossil fuel, to save foreign exchange on account of crude oil import bill & to reduce the air pollution, Government has fixed target of 10% blending of fuel grade ethanol with petrol by 2022 & 20% blending by 2025.”

It further reads, “To increase production of fuel grade ethanol and to achieve blending targets, the Govt of India has allowed use of maize and rice with FCI for production of ethanol. Government has declared that rice available with FCI would continue to be made available to distilleries in coming years. The extra consumption of surplus food grains would ultimately benefit the farmers as they will get better price for their produce and assured buyers; and thus will also increase the income of crores of farmers across the country.”

While EBP addresses a part of the current account problem, the implementation of three laws to reform the farm sector in 2020, could potentially address the fiscal deficit problem by improving the condition of the agri economy. Reforming the Food Corporation of India (FCI) by restricting its role to maintaining a strategic food reserve and substituting the public distribution system (PDS) of providing subsidized ration to poor with direct cash transfer (DBT) may result in significant savings for the government. However, this shall mean redundancy of the system of minimum support price (MSP) for wheat and rice. A strong demand vertical for wheat and rice in the form of grain based distilleries could be a good facilitator in this reform process.

Ethanol could impact the fiscal balance adversely at least in initial years. As of now Petrol is not covered under GST regime, whereas ethanol attracts GST. The GST on ethanol works out to between Rs 2.28– 3.13/litre, while the central excise duty on petrol is approximately Rs 33/litre. As per various estimates, E20 EBP might result in direct revenue loss of Rs100bn to the central government. Besides, poor fuel efficiency of blended fuel may need further subsidies to motivate the adoption of E20 fuel.

Sugar to ethanol – impact on sugar companies

The general view so far is that the EBP shall enhance the profitability of the sugar companies materially and also reduce the volatility in their earnings. In this context it is pertinent to note that-

·         The government took care of volatility in sugar prices, and hence earnings of the sugar producers, by prescribing a minimum selling price (MSP) for sugar in 2018. The MSP so prescribed affords a minimum profit to the producers, even in the seasons when the sugar production far exceeds the demand.

The EBP is expected clear the excess sugar inventory and restore the demand supply balance in sugar, through diversion of 6million MT of sugar to the manufacturing of ethanol.

·         Besides, ethanol pricing under EBP, has made the production of ethanol more remunerative for the sugar mills.

 

However, the forecasts made by various analysts might not be fully factoring in the following trends in their calculations:

 

At present pricing, ethanol produced directly from cane juice yields an EBIDTA of ~10%, which is half of the EBIDTA yield if ethanol is produced from molasses. It is therefore less likely that mills will be shifting majorly away from producing sugar at all.

As the sugarcane crop becomes more profitable, we may see further rise in acreage and productivity of sugarcane; in which case the problem of plenty may persist. Besides, in the year of drought when production of sugarcane is low, ethanol might have to take a backseat, impacting the projected profitability of sugarcane companies materially.

The biggest challenge would however come from material fall in global prices of fossil fuels due to popularization of alternatives like electric vehicles, worsening of demographics, and structural shift in travel habits and needs.

Electric vehicle

Sugarcane being a highly water intensive, and therefore energy intensive, crop in India, the more sustainable solution to current account and carbon emission would be electric mobility. The purpose is not served meaningfully if the electric vehicles are run on the power generated by thermal plants using the imported coal.

The salvation therefore lies in materially increasing the electricity generation through non-fossil sources; and developing technology for storage of such electricity using non-polluting sources. Hydrogen cells and other technologies mentioned in RIL vision for future will therefore be critical to achieve multiple objectives of sustainability, energy security, trade balance and fiscal improvement.

 

Now a question would arise, “Should we be buying the stock of Reliance Industries?” Well this is a question that does not fall in my domain. The readers may look elsewhere to find an answer to this.