The Hindu Business Line : Reining in ECBs

External Commercial Borrowings or ECBs, as they are better known, have been in the news recently. In May this year, the government lowered the cap on interest rates on ECBs and notified that ECBs were no longer permitted for development of integrated townships.

Last week, banking and technology stocks clocked handsome gains when the government announced curbs on overseas borrowings by companies. Before we figure out why all this is happening, we need to understand what an ECB is.

What is an ECB?

ECBs or External Commercial Borrowings refer to funds (debt) raised by Indian companies abroad in foreign currency.

ECBs include bank loans, suppliers’ and buyers’ credit, bonds including Foreign Currency Convertible Bonds (FCCBs) and credit from export credit agencies. ECBs were originally intended to finance projects in strategic sectors such as power, telecom, railways, ports and industrial parks.

These overseas borrowings can also be used for export financing. The government fixes an annual ceiling on the total amount that can be borrowed. Currently, a single company is allowed to raise up to $500 million a year through the ECB route.

Why Govt closely monitors ECBs

Any borrowing by a company from outside the country results in the flow of foreign currency into India. If this inflow is left unchecked, these external funds bring in inflationary pressures on the economy.

Consider the case of the dollar. An excess inflow of dollars in the form of Foreign Direct Investments (FDI)/Foreign Institutional Investments (FII) and External Commercial Borrowings (ECB) can prompt the rupee to appreciate vis-a-vis the dollar.

This is because every dollar that comes in increases the demand for the rupee. This, in turn, leads to an increased money supply in the economy resulting in inflation. The availability of cheap credit abroad (due to interest rate differences between domestic and foreign borrowings) encouraged many companies big and small, to take the ECB route for funding their projects.

Small and mid-sized companies, with not-so-impressive balance sheets, were found taking the FCCB route to borrowings, along the top-tier companies, leading to a sharp expansion in overseas liabilities for Corporate India.

Hence, in May this year, the government lowered the interest rates at which companies could raise funds abroad. This move had two implications.

One, it was expected to flush out smaller companies (with lower credit ratings) from approaching foreign lenders, as they would not find it easy to raise debt at the lower rates. Two, as a consequence of this, dollar inflows into the economy were expected to be checked , curbing inflation.

Last week, as a sequel to the above measures, it was announced that dollars raised (for borrowings above $20 million) via ECBs would have to be spent overseas and cannot be used to finance rupee expenditure.

Besides, even companies raising below $20 million to finance rupee expenditure will now have to take the permission of the RBI to do so.

Why thumbs-up from markets?

These curbs triggered positive sentiment towards select sectors in the stock markets. Restricting conversion of ECBs into rupee assets would bring down interest arbitrage opportunities. Hence, the move suggested that companies could become favourably disposed towards domestic borrowings.

Banking stocks made gains because this move meant higher loan offtake for them, at a time when they are flush with liquidity. This has positive implications for business growth.

IT stocks inched forward, as these restrictions were expected to halt the appreciating rupee, after a rise in the rupee dented their revenues and margins in the recent June quarter.

What it means to corporates

While the ECB curbs may be positive for banking companies, maybe even for IT stocks, if it stems the rupee rise, small and medium-sized companies with large capex plans may find an increase in their borrowing costs as they may have to look at domestic banks for credit or raise equity to fund their plans.

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