Everything About External Commercial Borrowing


1.Advantages and Disadvantages of External Commercial Borrowings

Though at times it may seem that a particular thing is perfect but the truth is that nothing can be totally perfect. Everything has to have some advantages and disadvantages. However, in the commercial sector disadvantages can be reduced by a suitable legal framework or at least their intensity can be reduced. Even the ECB™s are no exception and they too have their advantages and disadvantage both. Below provided are a few enumerations of such advantage and disadvantage, whereas the need for a better regulatory framework shall be dealt later in the project.

1.1  Advantages

  1. ECB allows companies access to funds in foreign currencies which may not be that easy to avail from the domestic market.
  2. The interest rate in global markets is lesser than the interest rate prevailing in the national market.
  3. Foreign lenders provide far more flexibility in terms of providing security for ECBs.
  4. Since the funds are raised through ECBs in foreign currency and the interest & redemption proceeds are also payable in the foreign currency, the issuing company has to hedge its foreign exchange exposure, which involves expenditure. In case the company opts to keep its foreign exchange exposure unhedged, it carries a huge risk due to fluctuation in foreign exchange rates. RBI has also acknowledged this problem and has instructed the banks to put in place a system for monitoring the unhedged foreign exchange exposure of small and medium enterprises.[1]
  5. The funds raised through ECBs have to be utilized in accordance with the end uses permitted under the guidelines; as such these funds cannot be utilized for working capital or general corporate purposes.[2]

1.2  Disadvantages

2. Regulatory Framework for External Commercial Borrowings

The Reserve Bank of India (RBI) is seriously concerned about the increased dependence on external commercial borrowings (ECBs) by Indian corporate houses. The worry is palpable when companies flock to the global markets shopping for loans when interest rates are down. Hence RBI has been stipulating the maximum amount that can be borrowed, the all-in cost ceiling (as done recently), end use etc. ECB can be accessed under the automatic route or the approval route. Under the automatic route, no approval is needed to access ECB. Under the approval route, specific approval from RBI is necessary. Broadly a borrowing not covered under automatic route requires approval of RBI. Generally, ECB allowed for a sector or end-use for the first time is kept under the approval route before being shifted to the automatic route. Further, banks and financial institutions have relatively more restrictions on accessing ECB. Borrowing, whether under the automatic or the approval route, are subject to numerous restrictions, including restrictions on who can borrow, who can lend, the terms of the borrowing, the uses to which the borrowed amount can be put (˜end-use™), the cost of borrowing (˜all-in-cost™) and so on.

A.    Automatic route

Eligible borrowers: Initially, only firms registered under the Companies Act, 1956, except financial intermediaries, were allowed to borrow under this route. Over time, the list of eligible borrowers has expanded to include certain categories of NBFCs, NGOs, Special Economic Zones (SEZs), and Micro Finance Institutions (MFIs).[3]

Recognised lenders: There are several internationally recognised lenders, such as international banks, international capital markets, and multilateral financial institutions such as International Finance Corporation (IFC), Asian Development Bank (ADB), and Commonwealth Development Corporation (CDC), export credit agencies, suppliers of equipment, foreign collaborators and foreign equity holders. Overseas organisations and individuals with a certificate of due diligence from overseas bank adhering to host country regulations are allowed to lend under the automatic route. Foreign equity holders are also recognised lenders under certain specified conditions.[4]

End-use restrictions: Borrowing is permitted for import of capital goods, modernisation or expansion of existing production units in the real sector, including infrastructure, and overseas direct investment in joint ventures and wholly owned subsidiaries. Over time, the list of permissible activities has been expanded to enable certain categories of NBFCs to avail of ECB for on-lending and leasing to infrastructure projects. ECB is also allowed for general corporate purposes by certain categories of eligible borrowers from direct foreign equity holders subject to certain conditions. It is generally not permitted for on-lending or investment in capital market, real estate, working capital, general corporate purpose and repayment of existing rupee loans.

B.     Approval route

Proposals falling under the category include: a) On lending by the EXIM Bank for specific purposes (case to case basis). b) Banks and financial institutions which had participated in the textile or steel sector restructuring package as approved by the Government. c) ECB with minimum average maturity of 5 years by NBFC to finance import of infrastructure equipment for leasing to infrastructure projects. d) Infrastructure Finance Companies (IFCs) i.e. NBFCs, categorized as IFCs, by RBI (beyond 50% of their owned funds) for on-lending to the infrastructure sector as defined under the ECB policy and subject to compliance of certain stipulations. e) Foreign Currency Convertible Bonds (FCCBs) by Housing Finance Companies. f) Special Purpose Vehicles (SPV) or any other entity notified by the RBI, set up to finance infrastructure companies / projects exclusively. g) Financially solvent Multi-State Co-operative Societies engaged in manufacturing. h) SEZ developers for providing infrastructure facilities within SEZ. i) Eligible Corporate under automatic route other than in the services sector viz. hotels, hospitals and software sector can avail of ECB beyond USD 750 million per financial year. j) Corporate in the service sector for availing ECB beyond USD 200 Mn. per financial year. k) Cases falling outside the purview of the automatic route limits and maturity indicated, etc.

End-use:  End-use would be the same for the funds raised under Automatic Route. The payment by eligible borrowers in the Telecom sector, for spectrum allocation may, initially, be met out of Rupee resources by the successful bidders, to be refinanced with a long-term ECB, under the approval route, subject to certain conditions outlined in the Circular.

C.     Current Limits

The companies in manufacturing and infrastructure sector and having foreign exchange earnings can avail of external commercial borrowing (ECB) for repayment of outstanding rupee loans towards capital expenditure and/or fresh Rupee capital expenditure under the approval route. The overall ceiling for such ECBs is $10 billion. For infrastructure sector companies, there is an overall ceiling of $ 20 billion. RBI has in September 2012, allowed companies to raise ECB up to a maximum period of 5 years for importing capital goods. Under the new norms, the trade credit should not be for a period of less than 15 months and also not in the nature of short-term rollover.[5]

3. External Commercial Borrowings and FDI

ECB means any kind of funding other than Equity. If the foreign money is used to finance the Equity Capital, it would be termed as Foreign Direct Investment. The ECB should satisfy the ECB regulations stipulated by the Government or its agencies such as RBI. The Bonds, Credit notes, Asset Backed Securities, Mortgage Backed Securities or anything of that nature are included in ECB.

The following are not included in the ECBs: Any Investment made towards core capital of an organization such as equity shares, convertible preference shares or convertible debentures. We should note here that those instruments which can be converted into equity are called convertible.[6]

4. Converting External Commercial Borrowings Into Equity

Reserve Bank of India (RBI) vide A.P. (DIR Series) Circular No. 94 January 16, 2014 has reviewed its circular on Conversion of External Commercial Borrowing and Lumpsum Fee/Royalty into Equity. The circular provides that an Indian company can issue equity shares against External Commercial Borrowings (ECB) subject to conditions and pricing guidelines as prescribed by the Reserve Bank from time to time regarding value of equity shares to be issued.[7]

5. External Commercial Borrowings and security instruments: The Ongoing Debate

There are broadly two sets of regulations application on capital account inflows Foreign Direct Investments (FDI), and External Commercial Borrowings and Trade Credits (ECBs). Very common misconceptions exist as to what transactions are covered under which Regulation, and whether the transaction in question is covered by either of these Regulations.

The word FDI covers investments in equity shares, compulsorily convertible debentures, compulsorily convertible preference shares. This is where money directly comes into a company whereas there are several forms of debt instruments through which Indian companies may source debt funding. These are commonly termed as external commercial borrowings (ECBs), foreign currency convertible bonds (FCCBs), foreign currency exchangeable bonds (FCEBs), preference shares and debentures which do not fall under FDI guidelines (see discussion above), and trade credits (TCs).

Under the FDI regime, investment can only be made into equity, fully and compulsorily convertible preference shares (CCPS) and fully and compulsorily convertible debentures (CCDs). Instruments which are not fully and convertible instruments are considered to be external commercial borrowing (ECB) and therefore, are governed by ECB regime. It is quite common for foreign investors to take up convertible instruments in Indian companies. These instruments are issued as either preference shares or debentures to begin with and are convertible into equity shares of the Indian company at a later date. The conversion may occur in one of two ways: either at the option of the investor, or compulsorily (without any option whatsoever). Such instruments carry characteristics of multiple securities and hence take on nomenclatures such as hybrids and quasi-equity. From a legal and regulatory (more specifically, foreign direct investment) standpoint, however, the question is whether such convertible instruments constitute debt, thereby falling within the purview of regulations governing external commercial borrowings (ECBs), or whether they constitute equity, thereby falling under the guidelines pertaining to foreign direct investment (FDI). Previously, all preference shares with an option to convert into equity were treated as FDI, and were counted towards the sectoral caps. As regards convertible debentures, although the policy does not appear to have been entirely clear, there have been instances where convertible debentures have been allowed by the Foreign Investment Promotion Board (FIPB) under the FDI        policy.[8] However, the according to Reserve Bank of India (RBI) in 2007 only fully and mandatorily convertible instruments are now considered to be FDI.

6. Conclusion

External Commercial Borrowings are a major source for raising debt capital for critical sectors that fuel the economy. Over the years the RBI has liberalized its approach towards external commercial borrowings and accepted the pivotal role it plays in the Indian economy. Yet problems remain due to overlapping of legislations like the RBI Master Circulars, FEMA, Companies Act 2013 and prevalent FDI policy. Such multiplicities of legislations further complicate the process of borrowing from external sources.

It is further prudent for the government to put more sectors under the Automatic Route and ensure that even down streaming of External Commercial Borrowing can happen from SEZ units to their subsidiaries. The External Commercial Borrowing serves as a much needed elixir for emerging sectors which may require high capital investment and there maybe lack of credit availability in the market.

Therefore, to conclude External Commercial Borrowing provides major impetus to Indian industry and has ushered in an era of high capital investment. The RBI in particular should be appreciated for being a harbinger for this rapidly popular mode of capital borrowing with respect to modernization and expansion of industry through importing foreign capital goods.

[1] Keyur Vinchhi, Critical Analysis of External Commercial Borrowings in India, Ideas Make Market, http://ideasmakemarket.com/2013/04/critical-analysis-of-external-commercial-borrowings-by-companies-in-india.html

[2] Id

[3] Report of the Committee to Review the Framework of Access to Domestic and Overseas Capital Markets (Phase II, Part II: Foreign Currency Borrowing) (Report III)

[4] Part I(I)(A)(ii), RBI/2014-15/3, Master Circular No.12/2014-15

[5] See http://www.gktoday.in/external-commercial-borrowings-2/#Routes_to_Access_ECB (Accessed on 11.09.2015)

[6] Id

[7] Singh & Associates, India: Conversion Of External Commercial Borrowing And Lumpsum Fee/Royalty Into Equity, Last Updated 3 March 2014, http://www.mondaq.com/india/x/296710/Shareholders/Conversion+Of+External+Commercial+Borrowing+And+Lumpsum+FeeRoyalty+Into+Equity

[8] India Corp Law, FDI: Compulsorily Convertible Debentures (Wednesday, March 25, 2009), http://indiacorplaw.blogspot.in/2009/03/fdi-compulsorily-convertible-debentures.html


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About Ambuj Dixit

Ambuj Dixit

Student of School of Law, KIIT University.

Corporate Law Referencer

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