How has RBI simplified External Commercial Borrowing? In order to facilitate Indian firms to raise money outside the country in foreign currencies, a financial instrument called External Commercial Borrowing or ECB is used extensively. RBI permits Indian corporate and PSUs to raise funds via ECB for various end uses including the expansion of their existing capacity; fresh investments; working capital or general business purpose. ECBs are in general, commercial loans which can be in the form of commercial bank loans, securitized instruments, suppliers’ credit, and buyers’ credit availed from non-resident lenders with a minimum average maturity of 3 years. However, it cannot be used for investment in the stock market or speculations in real estate; and is monitored and regulated by RBI through specific guidelines and policies.
Routes for “External Commercial Borrowing(ECB)”:
These specific borrowing instruments can be availed either through automatic route or by approval route. For the automatic route; RBI has permitted some eligibility criteria with respect to the industry, amounts, end use, etc. If a firm satisfies all the prescribed norms, it can get approval from RBI swiftly. Whereas for specific pre-specified sectors, the borrowers have to take explicit permission from RBI before borrowing through ECB. The Reserve Bank of India has issued formal guidelines and circulars pertaining to the rules for borrowing.
Only recently RBI has relaxed the norms for all eligible borrowers who can now raise up to $750 million or equivalent per financial year under the automatic route replacing the existing sector wise limits. This relaxation of norms has been a great relief for companies looking to raise funds through ECBs.
For domestic firms, External Commercial Borrowings have emerged as a valuable source of investable resource of funds which can be wisely utilized.
External commercial borrowing regulations and framework
RBI recently introduced a new framework with revised regulations –
Removal of track based ECB segmentation – Tracks I, II, III, and RDB (Rupee Denominated Bonds) or Masala Bonds are now merged into two simplified categories – Foreign currency denominated ECB and Indian Rupee denominated ECB.
ECB forms – RBI keeps updating the format of the forms, in past 12 months the format has been revised 3-4 times.
Eligible borrowers – All entities eligible to receive FDI under FEMA 20 (R) are now included.
Lenders’ norm simplified – Overseas lender needs to be a resident of FATF or IOSCO complaint nation.
Revised minimum average maturity Period (MAMP) – Uniform MAMP of 3 years is now prescribed for all types of ECB irrespective of the amount involved. However, for companies into the manufacturing sector, MAMP of 1 year (for ECB up to USD 50 million or its equivalent per financial year) and MAMP of 5 years is permitted for ECB raised from foreign equity holder and utilized for working capital purposes, general corporate purposes or repayment of rupee loans.
All-in-cost capping – ECB or Trade Credits cannot be used to pay interests and other charges.
Borrowing limits – Basis the sectors in which borrowers operate, borrowing limits have been set. Eligibility limit for firms into software development is USD 200 million, whereas infrastructure and manufacturing sectors, NBFCs, CICs, etc. have a limit of USD 750 million.
Relaxation of hedging norms for ECB
The RBI has instructed borrowers tapping into ECBs to cover the principal as well as the coupon through financial hedges, to effectively address currency risk at a systemic level. The designated AD Category-I banks are responsible for verifying hedging requirements. A borrower has to hedge in a manner that forex loss is minimized irrespective of the volatility in the foreign currency.
Illustrated calculation of average maturity for ECB
Name of the entity : XYZ Ltd
Loan Amount : USD 2 million
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How is ECB beneficial?
When borrowed from external sources, in general, the value of the funds is lower. For example, some economies have a lower interest rate, and Indian companies can borrow money at lower interest rates from the Euro zone and the US as the rates are comparatively low.
Since the markets are larger when raising funds through ECB, companies can meet larger requirements from international entities in comparison with what can be achieved through domestic players.
Through External Commercial Borrowing the company’s stakes will not be diluted. Hence, borrowers can raise funds without waiving control as debtors will not have any voting rights in the company.
Country’s economy is benefited. Inflows can be directed into the sector by the government, thereby increasing its potential for growth. For instance, a higher percentage of funding through ECB can be allowed for the SMEs and infrastructure industry. This helps significantly in the overall growth of the country.
What are Masala Bonds?
International Finance Corporation (IFC) coined the term to evoke Indian culture and cuisine. These are bonds that are issued outside India and denominated in Indian Rupees, rather than the local currency of that particular country. Unlike dollar bonds, the investor bears the currency risk in case of masala bonds. According to FAQ issued by the RBI, any corporate body and Indian bank is eligible to issue Rupee denominated bonds overseas.
However, these bonds come with certain limitations – as per RBI mandate, money raised through such bonds cannot be used for real estate activities other than for the development of integrated township or affordable housing projects. Masala bonds also can’t be used for investing in capital markets, purchase of land, and on-lending to other entities for such activities.
It may so happen that the Indian entity who has borrowed funds from a recognized lender is either not in a position to repay or for any other reasons wishes to issues equity shares in lieu of the ECB. Indian firms have been granted general permission for conversion of ECB into Equity shares or fully compulsorily and mandatory convertible preference shares, subject to the following conditions and reporting requirements:
The business of the company is covered under the Automatic Route for Foreign Direct Investment or Government (FIPB) approval for foreign equity participation has been obtained by the company, wherever applicable.
The sectoral cap is not breached by the foreign equity holding after such conversion of debt into equity, if any.
Company is in compliance with the requirements prescribed under any other statute and regulation in force.
Let’s assume, if an Indian firm has taken ECB for a period of 5 years and if it wants to convert the ECB before the expiry of 5 years, the same is possible.