External Commercial Borrowing Framework

External Commercial Borrowings

• External Commercial Borrowings is a loan availed by an Indian entity from a nonresident lender with a minimum average maturity.
• Most of these loans are provided by foreign commercial banks buyers’ credit, suppliers’ credit, securitized instruments such as Floating Rate Notes and Fixed Rate Bonds etc.
• Advantages of ECBs:
  • ECBs provide opportunity to borrow large volume of funds.
  • The funds are available for relatively long term.
  • Interest rate are also lower compared to domestic funds.
  • ECBs are in the form of foreign currencies. Hence, they enable the corporate to have foreign currency to meet the import of machineries etc.
  • Corporate can raise ECBs from internationally recognized sources such as banks, export credit agencies, international capital markets etc.

New Framework

• The RBI kept the borrowing limit under the automatic route unchanged at $750 million per financial year but replaced the sector-wise limits.
• RBI has expanded the definition of beneficiaries eligible for external commercial borrowings to include all entities that can receive foreign direct investment. Among those now eligible are: port trusts, units in special economic zones, microlenders, not-for-profit companies, registered societies/trusts/cooperatives and non-government organisations.
• The Export-Import Bank (EXIM) and the Small Industries Development Bank of India (SIDBI) has been allowed to borrow overseas from recognised lenders.
• The previous four-tier structure has been replaced by two specific channels: dollar- and rupee-denominated ECBs.
  • Earlier, there was a distinction between foreign currency ECBs based on maturity. One was maturity period of three to five years and the other of 10 years. Both have been subsumed into foreign currency-denominated ECBs.
  • Indian rupee-denominated overseas borrowings with similar sets of maturities have also been combined into a single rupee- denominated ECBs.
• To curb volatility in the forex market arising out of dollar demand for crude oil purchases, the framework provides a special dispensation to public sector oil marketing companies.
  • It allows them to raise ECB, with an overall ceiling of $10 billion, for working capital purposes with a minimum average maturity period (MAMP) of three years under the automatic route without mandatory hedging and individual limit requirements.
• The RBI has decided to keep the minimum average maturity period at 3 years for all ECBs, irrespective of the amount of borrowing, except for borrowers specifically permitted to borrow for a shorter period, like manufacturing companies.
  • Earlier, the minimum average maturity period was five years.
  • Further, if the ECB is raised from a foreign equity holder and utilised for working capital, general corporate purposes or repayment of rupee loans, the maturity period will be five years.
• Any entity who is a resident of a country which is financial action task force compliant, will be treated as a recognised lender.
  • This change increases lending options and allows various new lenders in ECB space while strengthening the anti money laundering/combating the financing of terrorism framework.
• The negative list, for which the ECB proceeds cannot be utilised, would include real estate activities, investment in capital market, equity investment, working capital purposes ( except from foreign equity holder), repayment of Rupee loans (except from foreign equity holder).
• Earlier in November, 2018 RBI also eased Hedging Norms for External Commercial Borrowings to make the ECB route attractive to firms.

The Sahoo Committee report on ECB

· The Sahoo Committee was set up in 2013, to develop a framework for access to domestic and overseas capital markets.

· The Committee made an assessment of the currency risk by Indian firms undertaking ECB.

· The Committee noted that the possibility of market failure can be ameliorated, by requiring firms that borrow in foreign currency to hedge their exchange risk exposure.

· The present complex array of controls on foreign currency borrowing should be done away with.

· The Indian domestic rupee debt market is a viable alternative to foreign borrowing for financing Indian firms and does not entail any market failure. · The policy should aim at removal of all impediments to the development of the domestic rupee debt market.

Change in ECB norms:

• It has been decided, in consultation with the Government of India, to liberalize some aspects of the ECB policy including policy on Rupee denominated bonds
• As per the extant norms, ECB up to USD 50 million or its equivalent can be raised by eligible borrowers with minimum average maturity period of 3 years
• It has been now decided to allow eligible ECB borrowers who are into manufacturing sector to raise ECB up to USD 50 million or its equivalent with minimum average maturity period of 1 year itself.
• Presently, Indian banks, subject to applicable prudential norms, can act as arranger and underwriter for RDB (Rupee Denominated Bond) issued overseas and in case of underwriting an issue, their holding cannot be more than 5 per cent of the issue size after 6 months of issue.
• It has now been decided to permit Indian banks to participate as arrangers/underwriters/market makers/traders in RDBs issued overseas subject to applicable prudential norms.
• The minimum average maturity requirement for ECBs (external commercial borrowings) in the infrastructure space raised by eligible borrowers has been reduced to three years from earlier five years.
• Additionally, the average maturity requirement for mandatory hedging (an investment to reduce the risk of adverse price movements in an asset) has been reduced to five years from earlier ten years.

Advantage of ECBs:

• ECBs provide opportunity to borrow large volume of funds
• The funds are available for relatively long term
• Interest rate are also lower compared to domestic funds
• ECBs are in the form of foreign currencies. Hence, they enable the corporate to have foreign currency to meet the import of machineries
• Corporate can raise ECBs from internationally recognized sources such as banks, export credit agencies, international capital markets

Disadvantages

· The growing importance of ECBs in the composition of external debt is a cause of concern for the Indian economy. Availability of funds at a cheaper rate may bring in lax attitude on the company’s side resulting in excessive borrowing.

· This eventually results in higher debt on the balance sheet which may affect many financial ratios adversely.

· Higher debt on the company’s balance sheet is usually viewed negatively by the rating agencies.

· This may result in a possible downgrade by rating agencies which eventually might increase the cost of debt.

· Effect on earnings due to interest expense payments.

· Since the repayment of the principal and the interest needs to be made in foreign currency, It exposes the company to interest and currency fluctuations.

· Companies may have to incur hedging costs or assume exchange rate risk which if goes against may end up negative for the borrowers.