De-jargoned | External commercial borrowing - Print View - Livemint

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Wed, Dec 19 2012. 08 38 PM IST

De-jargoned | External commercial borrowing

ECB is allowed through both direct and approval routes.
Rajesh Kumar External commercial borrowing (ECB) has emerged as a major source of raising funds for big Indian companies in recent years, while its increased dependence for bringing in foreign currency is a source of worry for some economists. What is ECB? Under the ECB window, companies in India are allowed to borrow from overseas, under certain conditions, through different instruments. The Reserve Bank of India (RBI), in its master circular on external commercial borrowing and trade credits (January 2012), defined ECB as commercial loans in the form of bank loans, buyers credit, suppliers credit, securitized instruments (e.g. floating rate notes and fixed rate bonds, non-convertible, optionally convertible or partially convertible preference shares) availed of from non-resident lenders with a minimum average maturity of three years.

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ECB is allowed through both direct and approval routes. Under the direct route, companies in businesses, such as hotel, hospitals and software, can access the international market for raising debt up to a limit. Special economic zones and non-government organizations engaged in micro finance activities are also allowed to access the ECB window. Companies of industries that can apply through the direct route can also take the approval route if they need to borrow more than the allowed limit under the direct route. Why do companies take the ECB route? The biggest incentive for companies raising money from overseas is the interest rate arbitrage. For example, even if a company borrows in the international market at 300 basis points (one basis point is a hundredth of a percentage point) above Libor (London Interbank Offered Rate), it will be able to borrow at just about 4% for one year; the cost of borrowing for a similar tenor will cost close to 10% in the domestic market. The idea behind opening up this window for sectors such as infrastructure and healthcare was to promote investment in these by providing the option of low-cost capital. The downside risk It is not that ECB is always beneficial to a company and the country and does not carry any risk. The borrower can be in trouble if the position is not hedged properly and the currency depreciates sharply, which will lead to increase in the companys liability. Also, at the macro level, higher level of borrowing from overseas may push the currency to appreciate, which makes exports uncompetitive in the international market. It is also argued that access to overseas market and cheaper credit is an advantage for bigger companies that can borrow abroad, while smaller companies have to deal with higher cost of capital in the domestic market. Finally, economists are worried that the dependence of the country on short-term debt flow, including ECB, is rising to fund the current account deficit and can have negative consequences.

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