The Reserve Bank of India (RBI) has discontinued a rule allowing companies to refinance an existing external commercial borrowing (ECB) at a higher all-in cost than their outstanding funding, which will negatively impact the flexibility with which corporations can fundraise offshore, according to bankers.
On September 30, the central bank published a note stating that the rule allowing eligible borrowers to refinance or reschedule an existing ECB at a higher all-in cost, has been discontinued. Fresh ECBs may still be raised at a lower cost, as long as the outstanding maturity of the original debt is either maintained or extended.
In a separate note, the RBI confirmed that it would keep the all-in cost ceiling unchanged. For ECBs with an average maturity of between three and five years, this must be lower than 350 basis points (bp) over six month Libor and for those over five years, the cost must be lower than a spread of 500bp.
“The move was surprising to many market participants including us, because it restricts a particular type of ECB at a time when otherwise the central bank is doing a lot to increase the supply of dollars onshore,” said one head of South Asia DCM.
Following a sharp decline in the rupee to an all-time low of INR68.85 to the US dollar on August 28, the RBI made a number of changes to allow new industries to use the ECB route.
In addition, the central bank is offering a temporary concession on the swap rate from US dollars into rupees. This means that banks can save an additional 200bp when they borrow in USD and swap the proceeds back into INR with the RBI. The facility is open until November.
However, from the government’s perspective, the new rule is in line with these policies. Allowing companies to refinance at a higher cost could lead to more FX outgoings, said one head of India treasury and markets. But for companies, it will prove restrictive, particularly in an environment where rates are rising.
“In this climate it’s going to be tougher for clients to refinance themselves at a cost lower than what they raised at earlier. This will lead to a lot of negotiations and discussion, as if lenders do not allow their customers to refinance at a lower all-in cost it will put the lender at a default risk,” he said.
Other options
One thing mitigating the negative impact of this rule is ECBs can now be raised for general corporate purposes. Until earlier this year the end use had to be linked to an approved capital expenditure.
The RBI’s definition of refinancing refers to funds that are already outstanding, rather than a fresh financing for any given company, said one head of DCM for South Asia. This means that companies will have more space to find reasons to take out fresh ECBs.
“Effectively what it will mean is no-one will be doing opportunistic deals they have been for a few years back. In the past, if you saw the spread was lower you could do a new transaction at a lower spread and extend the maturity,” he said. But in an environment of rising rates, borrowers would be unlikely to want to extend their maturities at a higher cost regardless of whether they are allowed to or not.
“Hypothetically if a borrower has a maturity coming up in the middle of next year and believes that the election will have a big impact on rates, they may want to refinance it now, but these situations are limited. It could be a problem, however, if a company breaches its covenants and lenders demand a higher margin,” he said.
However, on the whole, while companies may find it inconvenient not to be able to fundraise as opportunistically as they’d like, the immediate damage is likely to be limited. What concerns bankers is that the RBI is acting against the free market.
“I have spoken with the regulators about this – there is an ebb and flow that happens in international finance. In a risk off environment refinancing will be at a slightly higher cost and when the market is tightening then the pricing will be tighter. But our regulations are sometimes quite fixed on a number or on a principle and this can be a problem,” said the head of South Asia DCM.
He suggested that rather than providing a fixed level, the central bank could link the cap to a floating rate based on a proxy or an index. “The problem is that such an index does not exist at all in the loan market and in the bond market it can exist only with difficulty and tends to be volatile.”