ECBs face stiff end-use norms

The finance ministry on Wednesday virtually clamped down on external commercial borrowings by imposing end-use restrictions on all loans over $50 million, reducing the interest rate spread, making it mandatory to park unused proceeds abroad, and making it compulsory for borrowers to hedge green-channel foreign loans.

The comprehensive guidelines on external commercial borrowings released today also barred banks, financial institutions and non-banking financial companies from raising loans abroad or providing guarantees.

This will, however, not apply to external commercial borrowing proposals for the restructuring of the textile and steel sectors.

The Industrial Development Bank of India's $500 million proposal could, therefore, sail through.

Foreign loans exceeding $50 million can now be raised only for financing import of equipment and meeting the foreign exchange requirements of infrastructure projects.

Till now, the only restriction on the end-use of external commercial borrowings was on speculative investments and investments in real estate.

To ensure that the borrowings are staggered, the finance ministry has reversed its policy and asked companies to park unused loans abroad.

Officials said while there had been virtually no change in the norms for borrowing up to $50 million, the new policy made it clear that India Inc should source its large credit requirements from the domestic market.

The squeezed interest rate spread from 300-450 basis points to 150-300 basis points would make it virtually impossible for companies without a triple A rating to access foreign markets, said analysts.

A release issued by the ministry said the measures were temporary, "until further review."

Finance ministry officials said the piling up of foreign exchange reserves, which had topped $92 billion, a soft interest rate bias, and low credit offtake from domestic banks were the reasons behind the tightening of the external commercial borrowing norms.

The new guidelines will nix the plans of several private sector banks to raise foreign loans for their smaller clients, which do not have the financial strength to borrow at competitive rates.

As per the new guidelines, the all-inclusive ceiling on the interest spread over the six-month London Inter-Bank Offered Rate (Libor) has been reduced to 300 basis points from 450 basis points for projects over eight years.

For other projects, the ceiling will be 150 basis points over Libor, instead of the existing 300, while for infrastructure projects the new ceiling is 250 basis points instead of 400.

To curb the possibility of arbitrage between the rising rupee and the falling dollar, and also to dampen volatility in the foreign exchange market, the ministry has made it mandatory that external commercial borrowings for meeting rupee expenditure under the automatic route should be hedged.

The only exception is where there is a natural hedge in the form of uncovered foreign exchange receivables, which will be ensured by authorised dealers.

Move & Impact

End-use restriction over $50 million ECBs:

Pre-payment of high-cost foreign loans capped at $50 million, market for arbitrage killed.

Banks, FIs, NBFCs debarred from tapping ECBs: Will correct distortions in bond markets and ease pressure on deposit rates.

Interest rate spread lowered: Corporates with lower than triple A ratings will find it difficult to raise ECBs. Will also curb round-tripping of funds.

Proceeds to be compulsorily parked overseas: Will stagger inflow of forex, indicates RBI's comfort level with the reserves quantum.