External

Commercial

Borrowing

Introduction

External Commercial Borrowings (ECBs) play a significant role in any developing

economy since its domestic funds are usually unable to meet growing demand, more so

when the cost of domestic borrowing is higher than that of international funding.

Raising ECBs by Indian residents directly adds to India’s external debt and foreign

exchange exposure and therefore, the same is highly regulated by the RBI. Mismatch of

tenure and usage of ECBs can be disastrous for the economy as was evident from the

South East Currency Crisis. Therefore, many restrictions are placed by RBI to ensure that

short-term borrowings are not used for long-term use and vice versa. Policy guidelines

pertaining to ECBs have been revised from time to time. Recently, on August 1, 2005

new guidelines for ECBs have been announced. In this part, we shall discuss the

provisions related to raising of External Commercial Borrowings under the automatic

route of Reserve Bank of India.

External Commercial Borrowings (ECBs) are a key component of India’s overall external

debt which includes, inter alia, external assistance, buyer’s credit, supplier’s credit, NRI

deposits, short-term credit and Rupee debt. ECB guidelines, need to be assessed in the

backdrop of various external debt sustainability indicators relevant to emerging

economic needs.

Meaning

External Commercial Borrowings (ECBs) are defined to include commercial bank loans,

buyers’ credit, suppliers’ credit, securitised instruments such as floating rate notes and

fixed rate bonds etc., credit from official export, credit agencies and commercial

borrowing from the private sector window of Multilateral Financial Institutions such as

International Finance Corporation (Washington), ADB, IFC, CDC etc.

Even loans from Foreign Equity Holders are considered as ECBs.

Thus ECBs mean foreign currency loan raised by residents from recognised lenders.

Financial leases and Foreign Currency Convertible Bonds are also covered by ECB

guidelines.

ECB Guidelines — Historical prospective

ECBs, were governed by the Ministry of Finance. Government had issued consolidated

guidelines on policies and procedures for ECBs in July, 1999. The said guidelines were

amended from time to time. The Central Government had last revised these guidelines

on 19th January, 2004. However, subsequently RBI had issued comprehensive Circular

No. 60 dated 31st January, 2004, contents of which later on were incorporated by way

of amendments to the original Notification No. 3/2002-RB vide Notification No.

126/2004-RB, dated 13th December, 2004.

From 1st February, 2004 major restrictions were imposed on raising ECBs, by Indian

borrowers, such as ban on end use of ECB for working capital, general corporate

purpose, cap of US$ 500 million per financial year under the Automatic Route etc.

Submission of ECB-2 return to RBI on a monthly basis duly certified by the designated

Authorised Dealer as well as a Chartered Accountant was made mandatory with effect

from 1st February, 2004. On April, 2005, RBI permitted NGOs engaged in micro-finance

activities to raise ECB under automatic route vide its Circular No. 40. The revised

guidelines issued by the Government of India on 19th January, 2004 and the original

comprehensive guidelines of 1999-2000 have practically become redundant in the light

of these developments.

RBI has further amended its earlier ECB guidelines vide Circular No. 5, dated August 1,

2005. Notification making amendments based on these guidelines is still awaited.

ECB guidelines can be divided in three broad periods. Prior to 1st February, 2004, when

there were less restrictions on raising ECB and the same was allowed for general

corporate purpose including working capital requirements of companies. From 1st

February, 2004 to 31st July, 2005, ECBs were governed by RBI guidelines covered by the

A.P. (DIR Series) Circular No. 60, dated 31st January, 2004, which prohibited raising of

ECB for general corporate purposes/working capital and imposed several other

restrictions and reporting requirements. New ECB guidelines are announced by RBI

effective from August 1, 2005 which imposes further restrictions in terms of percentage

of shareholding by the leaders, permissible debt equity ratio and so on.

Provisions of ECB discussed in this Article are based on the latest RBI guidelines on ECB

covered by Circular No. 5, dated 1st August, 2005.

Different schemes of ECB

There are three broad schemes — or more appropriately, following facilities under ECB

schemes:

i. Trade Credit

ii. Automatic Route

iii. Approval Route

In this part, we will cover the first two schemes; i.e., Trade Credit and Automatic route

only.

Trade credit for imports into India

Trade Credits’ (TC) refer to credits extended for imports directly by the overseas

supplier, bank and financial institution for original maturity of less than three years.

Depending on the source of finance, such trade credits include suppliers’ credit or

buyers’ credit. Suppliers’ credit relates to credit for imports in to India extended by the

overseas supplier, while buyers’ credit refers to loans for payment of imports in to India

arranged by the importer from a bank or financial institution outside India for maturity

of less than three years. It may be noted that buyers’ credit and suppliers’ credit for

three years and above come under the category of External Commercial Borrowings

(ECB) which are governed by ECB guidelines.

Amount and maturity

ADs are permitted to approve trade credits for imports into India up to US$ 20 million

per import transaction for import of all items (permissible under the Exim Policy) with a

maturity period (from the date of shipment) up to one year. For import of capital goods,

ADs may approve trade credits up to US$ 20 million per import transaction with a

maturity period of more than one year and less than three years. No roll-over/extension

will be permitted by the AD beyond the permissible period.

As hitherto, ADs shall not approve trade credit exceeding US$ 20 million per import

transaction.

4.1.2 All-in-cost Ceilings

The all-in-cost ceilings are as under:

Maturity period All-in-cost ceilings

over 6 months LIBOR*

Up to one year 50 basis points

More than one year

but less than three

years

125 basis points

* for the respective currency of credit or applicable benchmark.

The all-in-cost ceilings include arranger fee, upfront fee, management fee,

handling/processing charges, out of pocket and legal expenses, if any. The all-in-cost

ceilings will be reviewed from time to time.

Guarantee

ADs are permitted to issue guarantee/Letter of Undertaking (LoU)/Letter of Comfort

(LoC) in favour of overseas supplier, bank and financial institution, up to US$ 20 million

per transaction for a period up to one year for import of all non-capital goods

permissible under Foreign Trade Policy (except gold) and up to three years for import of

capital goods, subject to prudential guidelines issued by Reserve Bank from time to

time. The period of such guarantees/LoU/LoC has to be

co-terminus with the period of credit, reckoned from the date of shipment.

Reporting arrangements

ADs are required to furnish details of approvals, drawal, utilisation, and repayment of

trade credit granted by all its branches, in a consolidated statement, on a monthly basis.

ADs are also required to furnish data on issuance of guarantees/LoU/LoC by all its

branches, in a consolidated statement on quarterly basis.

Automatic Route for External Commercial Borrowings up to US $ 500 million or its

equivalent during a financial year

Permissible entities

Indian companies registered under the Companies Act, 1956 are permitted to raise ECBs

up to US $ 500 million from reputed lenders in any one financial year (April to March).

Financial intermediaries like banks, financial institutions, housing finance companies,

NBFCs, Trusts, Non-Profit making Organisations (NPOs), Proprietorship/Partnership

Concerns and Individuals are not eligible to raise ECBs under automatic route.

Non-Government Organisations (NGOs) engaged in micro finance activities are eligible

to avail ECB.

Recognised lenders

The eligible entities can borrow in foreign currency by way of issue of bonds,

floating rate notes or other debt instruments from following lenders:

International bank or international capital market, or

Multilateral financial institutions, namely, IFC, ADB, CDC etc., or

Export Credit Agencies,

Foreign collaborator or foreign equity holder as specified by RBI, or

Supplier of equipments provided the amount of loan raised does not exceed the

total cost of the equipment being supplied by lender, or

Any other eligible entity as may be prescribed by RBI in consultation with

Government.

B. The key operative part in the credential of the overseas lender is that ECB should

be availed from an internationally recognised source and one of the recognised

categories is "foreign equity holder" as indicated above. It is clarified that for a

"foreign equity holder" to be eligible as "recognised lender" under the automatic

route would require minimum holding of equity in the borrower’s company as

under:

i. ECB up to US$ 5 million — minimum equity of 25 per cent

held directly by the lender.

ii. ECB more than US$ 5 million — minimum equity of 25 per

cent held directly by the lender and debt-equity ratio not

exceeding 4:1 (i.e., the proposed ECB not exceeding four

times the direct foreign equity holding).

Restrictions on use of funds

Borrower shall not utilise the funds borrowed under any of these Schemes for

a. Investment in stock market

However, ECB can be used for first stage acquisition of shares in the

disinvestment process, and also in the mandatory second stage offer to

the public under Government’s disinvestment programme of PSU shares.

b. Investment in real estate business

However, investment in "Integrated Townships" as defined by Ministry of

Commerce and Industry, Department of Industrial Policy and Promotion,

SIA (FC Division), Press Note 3 (2002 Series, dated 4-1-2002) is permitted.

It should be noted that the meaning of "Integrated township

development" is different from "real estate development". Construction

by a builder of a residential building or a commercial building is also real

estate development. NRI investment is allowed in this sector. But ECB

cannot be raised for such purpose. But if there is a project of township

development (which means large projects over 100 acres of land with

equity investment of at least US $ 5 million) then ECB can be raised.

c. On lending

One cannot borrow to lend, except in case of investment in JV/WOS

where loans also can be given. Foreign entity cannot lend in India to an

Indian entity to enable the borrowing entity to invest abroad. ECB can be

directly used by the borrower to invest abroad.

Refinancing of ECB (i.e., raising new ECB at lower interest rate and

repaying old ECB at higher interest rate) is permitted. However,

outstanding maturity of the old loan should be maintained.

d. General corporate purpose

ECB cannot be raised for general corporate purposes.

e. Repayment of existing rupee loans

ECBs cannot be raised for repayment of existing rupee loans.

Amount and maturity

Reserve Bank of India has prescribed limits for minimum average maturity for ECB

loans raised under the automatic route which are as under:

Amount of maturity ECB Minimum Average

(i) Up to US$ 20 million or its equivalent

Not less than three

Years

(ii) Above US$ 20 million and upto US$ 500 million

or its

equivalent

Not less than five Years

Borrowing up to US$ 20 million can have call/put option provided the minimum average

maturity of 3 years as prescribed above is complied with before exercising put/call

option.

The maximum amount of ECB which can be raised by a corporate is US$ 500 million

during a financial year.

Average maturity is defined as "weighted average of all disbursements taking each

disbursement individually and its period of retention by the borrower for the purpose of

ECBs."

All-in-cost ceiling

The amended Schedule I to Regulation 6(1) to the Notification No. FEMA.3/2000-RB

dated 3rd May, 2002 prescribes that "All-in-cost ceilings" for borrowing in foreign

exchange shall be specified by RBI from time to time.

The ceilings prescribed by RBI before the replacement of schedule is valid presently in

absence of any amendment thereto. The same are as follows :—

"All-in-cost" includes rate of interest, other fees and expenses in foreign currency except

commitment fee, pre-payment fee, and fees payable in Indian Rupees. All fees paid to

professionals, merchant bankers, expenses paid in foreign currency are covered in the

limit specified. Thus, it is annual cost limit rather than interest rate limit.

Moreover, the payment of withholding tax in Indian rupees is excluded for calculating the

all-in-cost.

Minimum average

Maturity Period

All-in-cost ceilings

over six month

LIBOR*

Three years and up to

five years

200 basis points

More than five years 350 basis points

* for respective currency of borrowing or applicable benchmark.

Thus, if LIBOR for US $ is 1%, then the rate for ECB for average maturity exceeding 5

years cannot exceed 4.5%.

RBI has clarified that all-in-cost ceiling must be calculated over a period of loan. Thus, in

a first year the cost may increase the prescribed limit but as long as the average cost

over the period of loan remains within the ceiling there is no problem.

Guarantees

Banks, financial institutions and Non-Banking Finance Companies shall not provide issue

guarantee or Letter of Comfort or Standby Letter of Credit in favour of overseas lender

on behalf of their constituents for their borrowings in foreign exchange.

4.2.8 Security

The choice of security to be provided to lender/supplier is left to borrower. However,

creation of charge over immovable assets and financial securities, such as shares, in

favour of overseas lender is subject to Regulation 8 of Notification No. FEMA 21/RB-

2000 dated May 3, 2000 and Regulation 3 of Notification No. FEMA 20/RB-2000, dated

May 3, 2000, respectively. In case of immovable property, a non-resident is not

permitted to acquire immovable property except in limited circumstances. Therefore,

for offering immovable property as a security, prior approval is necessary. Similarly for

shares being offered as security, while it is possible for a non-resident to acquire shares

under automatic route, under the normal circumstances, in case of security being

enforced, the acquisition of shares cannot be under automatic route. Therefore it may

be better to obtain prior approval from RBI.

Parking of ECB proceeds overseas

ECB proceeds should be parked overseas until actual requirement in India. It is clarified

that ECB proceeds parked overseas can be invested in the following liquid assets

(a) deposits or Certificate of Deposit or other products offered by banks rated not less

than AA(-) by Standard and Poor/Fitch IBCA or AA3 by Moody’s; (b) deposits with

overseas branch of an authorised dealer in India; and (c) Treasury bills and other

monetary instruments of one year maturity having minimum rating as indicated above.

The funds should be invested in such a way that the investments can be liquidated as

and when funds are required by the borrower in India.

Prepayment

Prepayment of ECB up to US$ 200 million may be allowed by ADs without prior approval

of RBI subject to compliance with the stipulated minimum average maturity period as

applicable to the loan.

Refinance of existing ECB

Refinancing of existing ECB by raising fresh ECB at lower cost is permitted subject to the

condition that the outstanding maturity of the original loan is maintained.

Debt servicing

The designated Authorised Dealer (AD) has the general permission to make remittances

of instalments of principal, interest and other charges in conformity with ECB guidelines

issued by Government/RBI from time to time.

Procedure

Borrower may enter into loan agreement complying with ECB guidelines with

recognised lender for raising ECB under Automatic Route without prior approval of RBI.

The primary responsibility to ensure that ECB raised/utilised are in conformity with the

ECB guidelines and the Reserve Bank regulations/directions/circulars is that of the

concerned borrower and any contravention of the ECB guidelines will be viewed

seriously and may invite penal action. The designated AD is also required to ensure that

raising/utilisation of ECB is in compliance with ECB guidelines at the time of certification.

Hedging

In cases where ECBs have been raised for meeting rupee expenditure under Automatic

Route, the Authorised Dealer has to ensure at the time of draw down that the forex

exposure of the borrower is hedged unless there is a natural hedge in the form of

uncovered foreign exchange receivables. [A.P.(DIR Series) Circular No. 23 dated 17th

September, 2002]

Drawal of loan

The borrower can draw-down the loan only after obtaining loan registration number

from DESACS, RBI.

Reporting requirements

a. In order to simplify the procedure, submission of copy of loan agreement

is dispensed with.

b. Borrowers are required to submit Form 83, in duplicate, certified by the

Company Secretary (CS) or Chartered Accountant (CA) to the designated

AD. One copy is to be forwarded by the designated AD to the Director,

Balance of Payments Statistics Division, Department of Statistical Analysis

and Computer Services (DESACS), Reserve Bank of India, Bandra-Kurla

Complex, Mumbai – 400 051 for allotment of loan registration number.

c. Borrowers are required to submit ECB-2 Return on monthly basis certified

by the designated AD so as to reach DESACS, RBI within seven working

days from the close of month to which it relates.

d. The loan agreement entered into by the borrower with the overseas

lender shall strictly conform to these Regulations.

In the subsequent part we shall discuss provisions relating to raising ECBs under the

Approval Route of RBI.

Conclusion

RBI liberalized ECB guidelines by permitting hotels,hospitals and software companies to avail ECB up to certainprescribed limits, although theretail sector has been left out.

ECBs have emerged as a forerunner in the credit market andhave steadily gained huge prominence in the Indian market. 

Indian government should tread cautiously and keep a checkon capricious borrowings from foreign lenders while at thesame time providing flexibility and keeping the health of theIndian economy in mind.