Demystifying ECBs

External Commercial Borrowing (ECB) is a cheap source of financing for India Inc due to the interest rate differential between India and the capital surplus overseas markets such as the US and Euro Zone countries. It helps bring down the cost of financing for Indian enterprises. However, borrowers should be aware of the risks associated with this form of financing as any adverse currency movement at the time of redemption of ECB could singe them.

What this means is that if the underlying exposure is not hedged and the rupee depreciates vis-a-vis the currency in which the borrowing is denominated, the borrower will come to grief.

Ashutosh Raravikar, Director, Department of Economic Policy & Research (DEPR), RBI, shines light on such risks and demystifies ECBs in his latest book — India’s External Commercial Borrowing: Features, Trends, Policy and Issues.

Financing costs

The author builds the narrative on ECBs over five chapters — The Conceptual Framework, The Journey of ECB in India, Evolution of India’s ECB Policy, Empirical Studies, and India’s External Debt Management: Issues and Policy Prescriptions — in easy to understand language. He has also provided many charts and tables to complement the narrative. Raravikar has underscored the fact that ECB, which is a commercial loan raised by an eligible resident entity from recognised non-resident entities, is a double-edged weapon and it boils down to the borrowers’ skill to use it to their advantage.

With interest rates in the US and Euro Zone currently being markedly lower than domestic rates, a corporate can save on its financing costs by taking recourse to ECB even after it takes into account associated costs such as hedging, guarantee fees and other transaction costs.

But then, the author also warns of the temptation to borrow excessively due to cheaper access to funds as this could adversely impact the borrower’s financial position due to exchange rate risk (if the tide turns) involved in servicing the debt. Hedging involves costs and this option may not be always available.

Commercial borrowings account for the largest component of India’s external debt. The author observed that higher magnitude of foreign debt could lead to rupee appreciation and reduction in the competitiveness of our exports. Hence, keeping the debt within limit keeps exports competitive and promotes export growth.

The author mentions that the six-month London Interbank Offered Rate (LIBOR) or any other six-month interbank interest rate applicable to a currency of borrowing such as Euro Interbank Offered Rate is the benchmark rate for ECBs in foreign currencies.

Raravikar opines that when it is not possible for the central bank of the country to allow high level of liquidity during inflation times, ECB is the best solution to push productive lending without implications for price rise. The author also gives valuable suggestions. He says the ECB framework should minimise the necessity for borrowers to have manual interaction with regulators. This would facilitate the business environment. In the context of domestic banks facing impending rise in bad loans and also becoming risk averse in lending, overseas borrowing can supplement this credit gap.

With the ECB market for some borrowers, whose rating was adversely impacted during the pandemic period, diminishing, Raravikar argues in favour of fresh policy measures, including upward revision in all-in-cost ceiling. This will help finance India’s growth needs. This book can be useful for entrepreneurs, CFOs, company officials responsible for mobilising resources, and MBA students, among others.

The author could consider including a small note on the global transition from LIBOR to the emerging benchmark (Secured Overnight Financing Rate) and its impact on ECBs when the book goes into a second edition.