The Reserve Bank of India has for years imposed a set of restrictions on Indian banks and corporations. Its "external commercial borrowing rules" are a set of guidelines that are notorious among foreign bankers, who find their options limited when dealing with Indian companies. The rules not only cap the amount Indian borrowers can raise offshore, they restrict the margins that can be paid, the maturities that can be used, and the way the money raised can be put to work.
There are few ways around them. Many Indian banks and corporations use their offshore entities to fund when turning to the international debt markets, but this only helps them skirt the rules if they are keeping the money outside the country. The rules are otherwise tough to avoid, and they restrict the willingness and ability of Indian borrowers to turn offshore.
But not all overseas bankers think that is such a bad thing. "The Reserve Bank of India is being prudent," says a senior loans banker in Singapore. "It is unwilling to let domestic companies borrow at exorbitant rates, and then struggle when a crisis comes.
"From a lenders perspective, these rules are very positive. There are some countries, like Indonesia, where debt is never paid back it is always just refinanced. But in India, you can see a history of debt repayments."
This is not a point always conceded by bankers overseas, nor by Indian borrowers. Some argue that the market should regulate itself: if lenders are really concerned about the same things as the Reserve Bank, they will not lend to companies that do not meet the guidelines, or they will charge prohibitive rates when they do lend, they say.
But there is little doubt that, while the regulations might leave a sour taste in the mouths of some offshore bankers, they also make credit analysis an easier task. Besides, things are not as tight as they seem on first glance. The government is willing to bend or even completely change the rules when it has to. The last few months have proved just that.
The rules they are a-changin
Among the plethora of rules facing Indian companies going overseas for financing is a restriction on the maturity a company can offer to international lenders or investors. Indian companies can sell three year deals if they want to, but they cannot raise more than $20m. Beyond that, they need to restrict themselves to five year deals or beyond.
This proved a thorny issue for Indian companies earlier this year. Loans bankers in Hong Kong and Singapore are often the default option for Indian borrowers turning to the offshore market, but this year as caution grew amid worries over Europe, a global economic slowdown and the looming implementation of the Basel III bank capital rules many of their old relationship banks pushed hard to keep maturities short. The problem was exacerbated by the decision of some European lenders to reduce their exposure to emerging markets.
This partly helps to explain why loan volumes from India were so lacklustre at the start of 2012, although the wider weakness of the loan market cannot be overlooked.
In any case, there is typically a slowdown in Indian offshore borrowing in the first quarter, since the period of January to March represents the last quarter of Indias financial year and companies tend to wait until the new financial year to really increase their offshore borrowing, according to bankers.
But even when the first quarter of the new financial year was included, the numbers did not look good. Indian borrowers raised only $7.74bn in the offshore loan markets in the first half of 2012, a drop of more than 22.3% compared to same period in 2011, according to Dealogic data. These numbers are actually slightly rosier than the broader drop in Asian lending. The amount of euro, dollar or yen deals closed in Asia ex-Japan during the first half of 2012 was down 29.4% from the year before.
The crucial difference came in the ability of bankers to improve on these numbers. Loans bankers focusing on India worried that, unless borrowers from the country got more flexibility with maturities, it would be hard for them to generate much more business in the second half. And that flexibility is just what they received.
The central bank decided to allow Indian state-owned companies more exemptions from its tough restrictions on maturities. That had a clear impact on the number of Indian borrowers turning to the international loan market.
Bank of India, ICICI Bank, Power Finance Corp, Rural Electrification Corp and Yes Bank are among the lenders which have opted for three year loans since July, approaching international lenders with deals worth multiple times the $20m limit.
These changes are clearly important for Indian companies and their relationship banks offshore: having more flexibility with tenors is an easy way to get more access to funding. But the Reserve Bank has proved even more aggressive in other areas, not just allowing exemptions to its rules, but in some cases changing them entirely.
The central bank has, for instance, given Indian borrowers more breathing room with the amount they can raise offshore without seeking approval for individual deals. The RBI releases a master circular on external commercial borrowing each July, and its latest release included an important change. Indian companies except those in the hotel, hospital and software sectors were told they could raise $700m in the financial year, an increase from the $500m they could raise in the year before.
Those in the hotel, hospital and software sectors face stricter borrowing limits, but they were still given some relief by the Reserve Bank in its latest external commercial borrowing announcement: they are allowed to raise $200m overseas across this financial year, double the amount they were permitted to raise in the year before.
Companies can raise even more when they seek approval from the central bank for fundraising. The update to the rules in July told companies that the overall limit of offshore funding was limited to 50% of a companys average export earnings over the last three years, but this amount was increased to 75% of these earnings in September.
Perhaps the most significant move of all occurred just as this report was going to print, when the finance ministry announced a widely hoped for cut in the withholding tax issuers need to pay on their foreign debt payments, cutting the rate from 20% to 5%. Bankers hope this change will make offshore fundraising a lot more attractive, combining with the other changes the government has announced to swell the supply of Indian bonds and loans offshore.
There is, however, another key area where the government has shown it is willing to adapt and it one that leads to a lot more debate. The central bank has given banks and corporations permission to pay higher interest rates on their international borrowings. But some bankers complain that even the existence of such limits hurts their chances of bringing Indian borrowers offshore.
Cap lifted, but not removed
Indian borrowers last year faced a margin limit that restricts all but the top companies turning offshore. They were permitted to pay no more than 300bp over six month Libor for deals of maturities between three years and five years, and no higher than 500bp over Libor for deals with tenors of more than five years.
The Reserve Bank has now increased the limit for three to five year deals, giving Indian borrowers an extra 50bp of breathing room. But this is unlikely to allow more companies to tap the offshore market instead it reflects the rising borrowing costs for those companies and banks that could already tap the market last year and bankers still say these limits are holding them back from helping finance smaller Indian borrowers.
"The government has taken a lot of steps this year to make it easier for Indian companies to fund offshore, but the maximum margin limits are still a problem," said a DCM banker focused on the country. "There are still a lot of companies that could not fund within those limits."
Some lenders still argue that these borrowing limits make sense: the central bank is making sure that Indian companies do not come under strain by paying rates which, if their businesses were to suffer, they would struggle to keep up.
But the unwillingness of the regulator to allow higher interest payments for offshore borrowings forces its hand elsewhere, leaving it little choice but to push ahead with the raft of rule changes and exemptions it has undertaken this year.
"The central bank feels the rupee loan market is overheating," said the Singapore-based loans banker.
"Small and medium enterprises are not big enough to tap the offshore market, so if the big boys are borrowing domestically in large size, they will put pressure on onshore liquidity."
These pricing restrictions do mean that India puts its best foot forward when allowing companies to turn to the international capital markets, giving bankers arguing for the benefits of the external commercial borrowing rules a further boost. After all, companies are not just forced to have the cash on hand to refinance; they also, thanks to price restrictions, have to be among the best-regarded issuers from the country.
But there is still a lot of debate between bankers and issuers in India over how helpful and necessary these rules really are.
Tight grip will continue
Indian banks are well known issuers in the international bond market, and regular borrowers in the loan market too. But offshore fundraising from corporations, especially in the bond market, is rarer ensuring good demand when deals do emerge.
The scarcity of supply from corporations is due to a variety of reasons: the pricing restrictions, tough rules on the use of proceeds of deals, and withholding tax on interest payments, to name just a few. But some bankers think the rules are flexible enough to ensure those corporations which have a real need can access the market, and think there is not a huge wall of supply waiting to be unleashed.
"We talk about these constraints as challenges, but they have not stopped any deals from happening, whether we are talking about capital formation or mergers and acquisitions," says Manmohan Singh, head of DCM in India at Royal Bank of Scotland.
This is a hotly-debated point, though. One of the key restrictions for Indian borrowers, outside of the maturity and pricing rules, is a limit on how the proceeds of a deal can be used. Borrowers can turn to the international markets to raise money for overseas investments, industrial expansion or infrastructure projects, among other things. But they cannot except for in certain sectors use the money they raise to buy local rivals, or to invest in real estate. Nor can they use more than a quarter of the proceeds to repay rupee loans.
This makes the credit work for bankers easier in many ways: the central bank has already laid out a specific list of end-uses of proceeds that are allowed, and bankers considering a deal can be sure the money they lend will not be used for speculation.
But it is not clear that it is necessary to restrict the use of proceeds before a company has even had discussions with a bank, since borrowers could just pay higher returns for a use that bankers perceived as more risky.
"Lenders and investors can make the call over whether your use of proceeds makes sense," says R Govindan, vice-president of corporate finance and risk management at Larsen & Toubro, a financial services firm.The debate over the Reserve Banks rules at times practical, at times philosophical will likely rage for years to come. Bankers do not expect the Reserve Bank of India to loosen its tight grip on offshore borrowing anytime soon. But for now the central bank has shown that, while it cannot loosen the rules enough to make everyone happy, it can make sure familiar faces have the ability to return to the capital markets again and again.