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ECBs to make industry more competitive
Posted on January 6, 2011 | Author: Anthony Toppo & Abdul Rasheed | View 243
Allow global money for refinancing domestic loans & selective on-lending.
Historically, external commercial borrowings (ECBs) have been permitted as an additional source of funds to encourage infrastructure and export sector financing. Nonetheless, the Reserve Bank of India (RBI) has been guarded in providing flexibility to Indian corporates looking to raise ECBs.
The RBI has been watchful about allowing rupee expenditure through ECBs because of its protectionist stand towards full capital account convertibility. Full capital account convertibility denotes free international capital movement, and the freedom to convert domestic currency into other internationally-accepted currencies and vice versa.
Ideally, an increase in external debt of the country should be matched by growth in its forex reserves to maintain solvency in the long run.
The RBI has been wary of the impact of full capital account convertibility on exchange rates — there being a currency risk involved in ECBs because depreciation of the rupee may lead to a higher burden for the borrower at the time of repayment.
Notwithstanding that, the RBI’s macroeconomic policies have allowed exchange rates to remain stable during the most volatile phase of global recession. The country’s GDP is pegged to grow at 8.8% in 2010-11. Industrial growth has been robust. The buoyancy in various service sectors witnessed in the second half of 2009-10 has continued this year. T
he latest quarterly industrial outlook survey conducted by the RBI indicates improvement in the overall business conditions. In the last two quarters of 2010-11, Indian companies have shown positive results.
Although there has been an increase in inflation over the years, by keeping interest rates high, the RBI has not allowed inflation to spiral out of control.
All these are positive indicators of real growth in the economy and mandate a gradual shift in RBI’s policy towards free flow of capital. In fact, flexibility in short-term loans from overseas markets may actually enable the government to reduce the GDP-to-public debt ratio.
Recently, the RBI approved domestic loan refinancing by ECBs for companies developing sea ports, airports and roads, including bridges, and power projects. This scheme is not available to companies in other sectors, such as retail, construction, services, etc.
Yet, domestic companies in other sectors require cheap source of finance to remain competitive in the global markets. Today, the cost of raising ECBs is much lower than that of domestic borrowings. ECBs can be availed of at interest rates as low as 4-5% (six-month Libor on December 4, 2010, was 0.462%).
In contrast, the base lending rates of most domestic banks are 7.5-8.5%. ECBs are a more viable alternative for Indian businesses as the global financial market is a much bigger source of credit.
Foreign lenders also offer far more flexible options when it comes to providing security for ECBs. The RBI should consider allowing this scheme of domestic loan refinancing by ECBs to other sectors as this can help companies in these sectors reduce their total cost of borrowing.
The RBI should also allow the use of ECBs for on-lending for permissible end-uses. Several domestic companies, especially in the infrastructure sector, engage in business by establishing wholly-owned subsidiaries (WOS) or special purpose vehicles (SPV) to implement specific projects.
Usually, these WOS/SPVs do not have strong balance-sheets or financial assets to take direct credit from overseas markets and, consequently, they are compelled to raise domestic debt at substantially high interest rates.
As the gestation period for infrastructure projects is very high, it can take several years for companies to start making profits. So, the low cost of borrowing in foreign markets can act as an incentive for these companies. This can encourage productivity in these sectors as well as boost foreign investment.
Some years ago, the RBI used to allow domestic companies to fund capital requirements of their Indian WOSs/SPVs by borrowing in foreign currency and on-lending for specified purposes. This was later changed by the RBI. The RBI should reconsider allowing on-lending of ECB in sectors, such as infrastructure, construction, services, etc, as this would greatly ease the burden of doing business in these capital-intensive sectors.
The RBI needs to support domestic companies looking to compete globally. For this, it needs to relax its stand on full capital account convertibility and rupee expenditure of ECBs.
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