India’s central bank has raised the ceiling for the external commercial borrowing (ECB) of Indian corporations, in a move that will help lower funding costs. But Indian companies have been known to take advantage of this scheme without hedging the loans, which means that the rule relaxation carries real risk to the country’s corporate sector.
ECBs are commercial loans from overseas lenders to Indian corporates that can take the form of bank loans, credit or securitised instruments, with an average tenor of around three years.
The amended regulation on September 11 raised the ceiling for the amount a company can borrow through ECBs, to use either for repayment of rupee loans or for future capital expenditure in rupees.
Previously, the ceiling was set at 50% of a company’s average export earnings in the last three fiscal years. Now, corporations can choose between 50% of its foreign exchange earnings over any single year of the past three years, or 75% of its average foreign exchange earnings over the previous three years, whichever is the higher figure.
The maximum limit for any corporation under the ECB borrowing scheme is US$3 billion.
On the whole, this should be positive for India’s corporate sector, which has been asking for a change in regulations as the cost of financing through bank loans remains high.
“The Indian corporate world has been clamouring about the very high interest rate regime over the last two years. Given that interest rates haven’t completely come down, corporates have been saying they need to tap offshore markets and avail of lower interest rates,” said one head of India at a rating agency.
“The RBI is fine with that and the ECB market actually is at least 50 basis points cheaper compared to the bond market, with the same comparative rating and comparative maturity.”
In addition, while the bond markets are sufficient for India’s larger companies, SMEs favour the ECB market, as it is possible to close a deal for as little as US$10 million.
“Previously the ECB route has provided much cheaper funding as the cost of financing domestically is much higher than funding offshore and converting it into INR. But the exact cost depends on the currency outlook and hedging costs,” said Kumar Rachapudi, India fixed income analyst at Barclays.
Commentators believe that offshore lenders would be willing to finance companies up to the new ceiling.
“There is some noise around ratings in India which may be hampering sentiment a bit, but if conditions improve globally that will have a positive effect. These guys who are willing to borrow should be able to find lenders, that should not be a problem to my mind,” said Rachapudi.
There has been much discussion surrounding whether or not rating agencies are likely to downgrade India’s credit rating from investment grade (‘BBB-‘) to sub-investment grade status.
Risky business
However, while the RBI has raised the ceiling, there has been no talk of ensuring that corporations are more cautious concerning the risks of leaving the funds unhedged.
“A large amount of ECB redemptions were due last year and that has left corporates under a huge amount of stress so if we see a similar situation then a repeat can be expected,” said Anubhuti Sahay, India analyst at Standard Chartered.
“The issue I find with corporate India is that not all of them hedge themselves fully and they play on the currency. So when there is an adverse currency movement like in the last 15-18 months that could completely put their calculations of the cost of ECB funding out of sync. If they have not hedged they are opening themselves to substantial risk,” agreed the India analyst from the rating agency.
The rupee has depreciated from INR47.65 to the dollar this time last year, to INR55.17 at the time of going to press, though this is down from the high in June of INR57.17.
Discussing whether the RBI should raise the ceiling further in order to allow corporations to avail of cheaper funding to a further extent, he advised caution.
“I don’t think they should increase it indiscriminately and to everybody. They would need to assess the risks on a case-by-case basis, there is no free lunch,” he said.
While the change in regulations will affect individual corporations, analysts argue that the greater market impact will be limited.
“They have been making ECB modifications in a staggered manner and we have not seen a significant positive impact per se. First of all there is a question of borrowing appetite, and also there are now concerns about India’s rating story in the next few years which effectively means pricing becomes an issue,” said Sahay.
Arvind Mayaram, secretary of the department of economic affairs, said to local press in New Delhi on September 11 that one of the motives for the change was to attract foreign inflows into the country in order to keep the Indian currency lower for longer. But commentators argue that the impact in this respect will be limited.
“These measures will help only at the margin we do not expect to see a significant impact. It won’t bring in a huge amount of extra inflows,” said Sahay.
“It’s a pretty large and deep foreign currency market so I don’t think this will have any real impact on the exchange rate or the domestic interest rate but it is a positive in that the availability of funds is at a lower cost for corporations,” concluded the credit analyst at the rating agency.