External Commercial Borrowings (Ecb) – The Good, The Bad And The Ugly

It would not be news to anyone to hear that Indian economy finds itself in a tough spot today. Just a few days ago, the repo rate was increased 50 bps, which in turn led to an increase in the rate of interest on borrowings. In such a situation, it is unsurprising that most corporates and other institutions are preferring borrowing from foreign sources rather than from within the country. One of the avenues for this is External Commercial Borrowing, a method becoming increasingly popular day-by-day. In fact, in the month of April’22 alone, the total borrowings from external sources through ECBs was US $36,16,01,296.

What are ECBs?

External Commercial Borrowings [“ECB”], are regulated under Section 6(3)(d) of the Foreign Exchange Management Act [“FEMA”] and regulations formed under it, namely the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 and the Foreign Exchange Management (Borrowing) Regulations, 2000. These regulations also provide the RBI with powers to mould the boundaries within which such transactions shall place.

ECBs are commercial borrowings by an Indian entity from any recognized organisation outside India. However, not all Indian entities can avail of this service; it is necessary to be within the ambit of an “eligible resident entities”. In addition, the borrowing from such sources should fulfil certain parameters as well, which shall be elaborated upon further on in the article.

According to the instructions given by the “RBI”, this Indian entity must be eligible for “FDI”, for instance, Port Trusts, Units in Special Economic Zones, SIDBI and EXIM Bank of India. On the other hand, in order for a foreign lender to be “recognized”, they should be a member of either the “IOSCO” or the “FATF”. “Recognized lender” also includes regional and multilateral finance institutes of which India is a member, or even Indian banks’ foreign subsidiaries, provided they are foreign equity holders i.e. either having 25% equity in case of direct holding or 51% equity in case of indirect holding.

Routes to ECBs?

In order to be a part of ECBs, there are two possible approaches that can be taken by the borrower, the approval method and the automatic method.

1. Approval Method – as the name connotates, in this method the explicit authorization of the RBI or the Government is essential prior to actually borrowing from a recognized lender.
2. Automatic Method – to fall under this category, the borrower simply needs to fulfil the eligibility requirements as created by the RBI and the Government. Under this method, these authorities regulate the amount of money borrowed, the apparent industries in which it is to be utilized and the actual use of the borrowings as well.

What is the Sahoo Committee?

Back in 2013, the Sahoo Committee was formed to assess the position of ECBs in the Indian economy. Its aim was to bring into being a map for Indian entities to dip their hand in domestic and international capital markets.

In the Report presented by the Committee at the end of the review, it was noted that requiring firms that borrow in foreign currency to hedge their exchange risk exposure can reduce the possibility of market failure. It also concluded that the debt market within India itself is a viable alternative to ECBs and the aim of the government should be to eliminate procedural duress from borrowings through strictly regulating such transactions.

Post the 2019 Amendment by the RBI:

In January of 2019, the RBI put forth a revised edition of regulations governing ECBs. Earlier, due to rigid provisions under the relevant regulation, ECBs were classified in three tracks: given as under:

1. Medium-term foreign exchange denominated ECB.
2. Long-term foreign exchange denominated ECB.
3. INR denominated ECB.

Within the new guidelines, the RBI has prescribed only 2 tracks, the Foreign Exchange Denominated ECB and the INR Denominated ECB.

Similarly, in the case of “recognized lenders”, instead of providing for a specific lender for a specific track as was done in the earlier regulations, the amended version established a simple rule for qualifying as a recognized lender, which is that the institution giving the loan should either be part of an FATF or IOSCO compliant country, subject to certain exceptions, as and when applicable.

Secondly, it loosened the definition of “eligible borrower” to mean all institutions for whom it is feasible to receive FDI as compared to earlier, when there were specific criteria provided to become an “eligible borrower” for each of the three tracks.

Thirdly, the New Framework also relaxed the tight grip on ECBs by allowing an Indian subsidiary to borrow from its parent company, again subject to certain conditions; the general limit on amount borrowed externally is US $750 million or an equal amount in other currencies, but if the amount borrowed is from a direct equity holder, it will also come under the ECB liability of the equity ratio requirement. In addition, the liability of the Indian entity in such a case towards the foreign equity holder i.e. an amount greater than 7 times the contributed equity is not allowed.

Fourthly, under this revised guideline, a negative list of end-uses is provided, and the same is as given below:

1. Equity investment;
2. General corporate purposes, except from foreign equity holders;
3. Investment in capital markets;
4. On-lending to entities for the afore-mentioned activities.
5. Real estate activities;
6. Repayment of Rupee loans, except from foreign equity holders; and
7. Working capital purposes, except from foreign equity holders;

Lastly, the Minimum Average Maturity Period [“MAMP”] has been amended as well. Whereas earlier a separate MAMP was prescribed for each of the three tracks, it is now a uniform period of three years, subject to the following exceptions:

When borrowings are raised externally –

(i) for working capital purposes from a foreign equity holder, or general corporate purposes from the same or for rupee loans which need to be repaid, the period of maturity will be five years;

(ii) by Companies in the manufacturing sector, when the borrowings are up to US$50 million or equivalent in every financial year, the period of maturity will be one year;

(iii) (a) for general corporate purposes or working capital purposes and (b) on-lending by NBFCs for the same purpose, the period of maturity will be ten years;

(iv) (a)in the form of Rupee loans taken domestically to be repaid for capital expenditure (b) on-lending by NBFCs for the same purpose, the period of maturity will be seven years;

(v)(a) in the form of Rupee loans taken domestically for purposes other than capital expenditure which need to be repaid (b) on-lending by NBFCs for the same purpose, the period of maturity will be ten years.

However, it is also specifically mentioned in the RBI Master Directions that for categories (ii) to (v), the amount cannot be borrowed from foreign branches or subsidiaries of Indian banks. In addition, the given period of maturity should, under no circumstances, be breached.

Advantages of ECBs:

1. The first and foremost gain from being a borrower under ECB is that the interest rates to be paid on these loans is generally lower than what these Indian entities would have had to pay had they taken a loan from within the country.
2. In addition, these loans are provided for a relatively long period, which is highly advantageous to the borrower.
3. Another advantage of this scheme is the fact that the process is entirely too simple. The debtors would have no voting rights in the company which means that the amount of control that the borrower has would remain unchanged.
4. Taking loans from a foreign source will be in foreign currency which provides the Indian entity with easy access to resources to utilize when importing from foreign countries.
5. The sector of the economy which is experiencing an inflow of foreign loans will grow at a pace which was earlier unprecedented. The government can allow a greater inflow of cash through ECBs in a sector they feel needs the resources to supplement its growth, like SME and infrastructure industries.
6. In addition to the growth experienced by the borrower, the process of borrowing from foreign sources also exposes these entities to global players and their working.

Disadvantages of ECB:

As lucrative as the idea sounds, there are always two sides to the coin.

1. As advantageous as ECBs are, they are, at the end of the day, a debt. If the RBI and the Indian Government become too lax with the application of rules and regulations with respect to external borrowings, companies might start biting off more than they can hew, leading to difficulties in paying back the loans accumulated. This in turn would lead to a market downgrade for such companies.
2. Debts also affect the market value of companies. Market value is intricately tied up with the stock market and a heavily indebted company might face a stock decline in the future.
3. While there are advantages to receiving loans in foreign currency, it should not be forgotten that the same is heavily reliant on the currency exchange rates prevalent at the time. As any normal loan functions, ECBs must be paid back with the principal and interest amount accumulated on the principal. If the currency exchange rate at that time is not favourable to the Indian borrower, paying back the loan can be a heavy price to pay.

Conclusion:

From the above discussion, it is clear that ECBs have a very clear-cut advantage for the Indian Economy today. However, considering the recent relaxation of rules and regulations on the part of the RBI, in association with the Government of India, spells out trouble for the future. If borrowings are so easily available for Indian entities, it will put into force a rapid increase in the cumulative debts of Indian companies undertaking ECBs and, in turn, the country’s balance sheet will reflect the same. The possibility of being unable to pay back the debts is a very real one and considering the volatility of the currency exchange rate, it is apparent that ECBs are fraught with risks. In addition, the regulations fail to completely define whether a Limited Liability Partnership [“LLP”] is also eligible for an ECB, making it rather challenging for LLPs in India to navigate the sometimes murky waters of the New ECBs Framework.

In addition, the entire system is heavily dependent on the way the amount borrowed is utilized in reality. If the ECBs does not yield the desired result and fails in promoting growth in the industry for which it was undertaken, the ultimate purpose of the ECB remains unachieved. The inflow of foreign currency would be reflected in the balance sheets, but with no actualgrowth supplementing it, an ECBs might leave the country worse off as compared to now.

Due to this, it is of significant importance that the rules regulating such transactions be tightened. The relaxation granted to eligible Indian entities now is sudden and misuse of the facility can be done very easily. The Government of India along with the RBI need to have a bird’s-eye-view of the situation and take into consideration the fallouts of such measures and the possible impact it might have on the economy.

Author: Bhavishya Mohaniya  and Garima Chauhan – legal Interns at  IP And Legal Filings, in case of any queries please write back us via email at support@ipandlegalfilings.com.