External Commercial Borrowings: A Perspective In Light of The Recent Change

As most of us will be familiar, the RBI has notified the Master Circular on External Commercial Borrowings (ECB) and Trade Credits on the first day of this month summarizing the legal framework governing ECB in India. The document runs long and is replete with changes with regard to eligible borrowers, recognised lenders, all-in cost ceilings, end-use requirements and permissible security among many others.

However, on a closer look, one will probably notice that the RBI failed to induce effective new changes in some cases and some of the old provisions, which were done away with by the 2008-2009 Master Circular, have merely been reintroduced. Such provisions have been enumerated below:
1. NGOs engaged in micro-finance activities, which were mandated to take RBI approval if they wanted to avail ECB by the 2008 Master Circular, have once again been brought under the Automatic Route. The eligibility criteria for such NGOs remain unchanged. The cap of 5 million on such loans and designated AD Bank's liability to ensure the hedging of the forex exposure at the time of drawdown stand untouched.

2. Overseas Organizations and Individuals may also provide loans to NGOs engaged in the Micro-finance activities under the Automatic Route subject to certain considerations. They were knocked off the Automatic Rote in the last year's Master Circular. The conditions for the 2 entities to qualify as eligible lenders remain unchanged as well.

3. Use of ECB proceeds for the first stage acquisition of shares in the disinvestment process and also in the mandatory second stage offer to the public under the Government's disinvestment programme of public sector undertaking shares were excluded from the Automatic Route and had been brought under the approval route in 2008. They have once again been brought under the automatic route.

Why these changes were incorporated last year and if done with a judicious perspective, why were they reconciled again remains unanswered.
The new provisions added in the current framework are mostly fitting but some of them seem to lack in prudence.

The latest changes in the ECB legal framework are outlined below:

1. The All-in Cost ceilings for the automatic route have been raised to 300 basis points from erstwhile 200 basis points above the average of last 6 months LIBOR for ECBs having maturity period within 3 and 5 years. For ECBs having maturity period more than 5 years, the all-in cost ceilings have been further raised to 500 basis points from erstwhile 350 basis points above the last 6 months average LIBOR. Also, if any person wishes to borrow at a rate beyond the specified all-in-cost ceilings, he may now do so after taking RBI approval.

This liberalization, however, is given only till the 31st of December, 2009, when it will be reviewed again. Liberalizing the all-in-cost ceilings in a world plagued by credit crunch is obviously a positive and thoughtful measure. Small and medium enterprises, as a result, may not be neglected anymore by the international lending agencies as was done when there existed a cap on the all-in-cost ceilings.

2. Corporates in the service sector (namely, the software sector, hotels and hospitals) have now been brought under the Automatic Route from under the Approval Route and may raise ECB without any kind of Approval from the RBI but only up to a cap of USD 100 million for all rupee related or foreign currency expenditure. This is only fair since we see a lot of foreign funds coming into these sectors.

3. The Infrastructure sector has now been re-defined to include mining, exploration and refining as well.

4. Specified end-uses under the Automatic sector have now been widened to include payment for obtaining license/permit for 3G spectrums, for lending to self-help groups or for micro-credit or for bona fide micro finance activity including capacity building by NGOs engaged in micro finance activities and for premature buy-back of FCCBs.

5. Corporates engaged in the development of integrated townships are now allowed to raise ECBs subject to RBI Approval.

6. Special Economic Zone (SEZ) developers and corporates engaged in the development of integrated township under the list of eligible borrowers for the Approval route. However, a SEZ developer is not allowed to raise ECB for the development of commercial real estate or integrated township within a SEZ.

Here is created a mammoth inconsistency.If development of integrated township is permitted in the first place and so is the development of infrastructure facilities within the SEZ, what objective is being sought by disallowing SEZ developers from accessing ECB for development of integrated township within the SEZ? In my opinion, this amounts to discouraging infrastructure development and bears no nexus with the ECB Policy.

7. NBFCs exclusively involved in financing of infrastructure sector can now avail ECBs under the Approval Route from multilateral financial institutions, reputable regional financial institutions and Government owned development financial institutions for on-lending to the borrowers in the infrastructure sector.

8. ECB can now also be raised for buy-back of FCCBs subject to RBI Approval.

9. The previous regulations pertaining to ECBs did not make it clear if defaulting companies, guilty of having violated the ECB policy, could access further ECBs. By bringing them under the approval route, the RBI has made it clear that it will be decided on a case by case basis.

11. The new Master Circular also assigns some additional safeguards to be taken by the AD Category I Banks before according a no-objection certificate in case of a creation of charge on immovable assets, financial securities and issue of corporate or personal guarantees in favor of an oversees lender/security trustee, to secure the ECB to be raised by the borrower.

The AD Category I banks should ensure that:
(i) the underlying ECB is strictly in compliance with the extant ECB guidelines,
(ii) there exists a security clause in the loan agreement requiring the borrower to create charge on immovable assets / financial securities / furnish corporate or personal guarantee,
(iii) the loan agreement has been signed by both the lender and the borrower, and
(iv) the borrower has obtained Loan Registration Number (LRN) from the Reserve Bank.

a) The 'no objection' for creation of charge on immovable assets may be conveyed under FEMA, 1999 either in favour of the lender or the security trustee, subject to the following conditions:
(i) 'No objection' shall be granted only to a resident ECB borrower.
(ii) The period of such charge on immovable assets has to be co-terminus with the maturity of the underlying ECB.
(iii) Such 'no objection' should not be construed as a permission to acquire immovable asset (property) in India, by the overseas lender / security trustee.
(iv) In the event of enforcement / invocation of the charge, the immovable asset (property) will have to be sold only to a person resident in India and the sale proceeds shall be repatriated to liquidate the outstanding ECB.

b) AD Category – I banks may convey their 'no objection' under FEMA, 1999 to the resident ECB borrower for pledge of shares of the borrowing company held by promoters as well as in domestic associate companies of the borrower to secure the ECB subject to the following conditions:
(i) The period of such pledge shall be co-terminus with the maturity of the underlying ECB.
(ii) In case of invocation of pledge, transfer shall be in accordance with the extant FDI policy.
(iii) A certificate from the Statutory Auditor of the company that the ECB proceeds have been or will be utilized for the permitted end-use/s.

c) The 'no objection' to the resident ECB borrower for issue of corporate or personal guarantee under FEMA, 1999 may be conveyed after obtaining the following:
(i) Board Resolution for issue of corporate guarantee from the company issuing such guarantees, specifying names of the officials authorised to execute such guarantees on behalf of the company or in individual capacity.
(ii) Specific requests from individuals to issue personal guarantee indicating details of the ECB.
(iii) Ensuring that the period of such corporate or personal guarantee is co-terminus with the maturity of the underlying ECB.

12. Under the Trade Credits regime, the erstwhile all-in-cost ceilings were different for short term trade credits and long term trade credits. For short term trade credits with maturity period of up to 1 year, the all-in-cost ceilings were 75 basis points above 6 months LIBOR. And for long term trade credits extending up to 3 years, the all-in-cost-ceiling was 125 basis points above 6 months LIBOR. This differentiation have now been done away with and the all in cost ceilings for all kinds of Trade credits extending up to 3 years, has been fixed at 200 basis points above 6 months LIBOR.

13. The requirement of parking ECB funds outside India till the actual requirement is felt in India has been done away with. Borrowers now have the choice to keep the ECB proceeds parked outside or can remit them into India if they so desire. There is a fiscal cost that the economy pays when ECB proceeds are remitted into India. RBI accumulates foreign currency assets by using domestic currency to buy the forex from those who have acquired it through remittances, which may lead to domestic currency expansion. In order to counteract the same, RBI sterilizes the forex accretions by selling domestic securities in the domestic market to absorb the excess domestic currency released. Sterilized intervention implies a cost which may be defined as the difference between the interest earned on forex reserves and the interest paid on domestic securities placed for sterilization. Especially in a time when the fiscal deficit has surged to 6.2% of the gross domestic product, how prudent is it to allow ECB borrowers to remit the borrowed amount as and when they want to? Thus, the freedom of borrowers to keep ECB proceeds overseas or to remit the same into India might not be a fiscal friendly step.

Concluding, though the current legislative framework for ECB is aimed at the controlled liberalization of inflow of foreign funds, it would probably serve the interest of the broader economic objectives had the RBI weighed each introduction against the basic ECB Policy.

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