External Commercial Borrowings Shaik Majid

7/29/2019 External Commercial Borrowings Shaik Majid

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EXTERNAL COMMERCIAL BORROWINGS & BUYERS CREDIT-

OPTIONS FOR LONG TERM & SHORT TERM BORROWING

REQUIREMENT FOR MNCS

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ABSTRACT

In this project, titled External commercial borrowings & buyers credit-

options for long term & short term borrowing requirement for MNCs The aim is

to analyze whether ECB for long term and BC for short term borrowing for the

MNCs, is best option, with detailed look on procedure for application, guidelines,

compliances, Indian government policy, rules and regulations placed at present.

This project study will enable finance manager to understand the options

viz, ECB and BC, and make use of the same if its feet in for his organization and

save borrowing /interest cost.

The study explains ways in which both these options can be of assistance

in long-rang planning, budgeting and borrowing cost management to strengthen

financial performance and help avoid financial difficulties.

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INTRODUCTION

An external commercial borrowing (ECB) is an instrument used in India to

facilitate the access to foreign money by Indian corporations and PSUs (public

sector undertakings). ECBs 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

borrowings from the private sector window of multilateral financial Institutions

such as International Finance Corporation (Washington), ADB, AFIC, CDC, etc.

ECBs cannot b e used for investment in stock market or speculation in real estate .

The DEA (Department of Economic Affairs), Ministry of Finance, Government of

India along with Reserve Bank of India, monitors and regulates ECB guidelines

and policies.

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Detailed look on procedure for application, guidelines, compliances, Indian

government policy, rules and regulations placed at present

External Commercial Borrowings (ECB) refer to commercial loans in the form of

bank loans, buyers credit, suppliers credit, securitized instruments (e.g. floating

rate notes and fixed rate bonds, non-convertible, optionally convertible or partially

convertible preference shares) availed of from non-resident lenders with a

minimum average maturity of 3 years.

ECB can be accessed under two routes, viz., (i) Automatic Route, i.e. do not

require Reserve Bank / Government of India approval. and (ii) Approval Route, in

case of doubt as regards eligibility to access the Automatic Route, applicants

may take recourse to the Approval Route.

Master Circular on External Commercial Borrowing released by Reserve bank of

India on yearly basis in July month every year on website

Hyperlink : to access RBI Portal Master Circular

http://www.rbi.org.in/scripts/BS_ViewMasterCircularde t ails.aspx

RBI Master Circularon ECB and trade Credits.pdf

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To avail ECB one must go through above Master circular and understand

following concepts defined therein for automatic and approval route.

1. Eligible Borrowers

2. Recognized Lenders

3. Amount and Maturity

4. All-in-cost ceilings

5. End-use

6. End-uses not permitted

7. Guarantees

8. Security

9. Parking of ECB proceeds

10. Prepayment

11. Refinancing of an existing ECB

12. Debt Servicing

13. Procedure

14. Refinancing/rescheduling of an existing ECB

After understanding above concepts, eligible borrowers can enter into agreement

with recognized lenders adhering to maturity and all in cost ceiling. Eligible

Borrower need to file Application in Form 83 to Reserve bank of India through

Authorized Dealers.

Hyperlink : to see list of Authorized Dealers

http://www.rbi.org.in/commonman/English/scripts/authorizeddealers.aspx

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Form 83 in brief:

Form 83 is an application form to be submitted to Reserve Bank of India

reporting of loan agreement details within 7 days of signing of such agreement,

for allotment of LRN (Loan Registration Number). This Application form

containing details of lender and borrower, foreign currency of loan, interest rate

i.e LIBOR (London Interbank Offer rate) Plus basis Points. At present all in cost

ceilings is as given below

Average Maturity Period All-in-cost Ceilings over 6 month

LIBOR*

Three years and up to five years 350 basis points

More than five years 500 basis points

* for the respective currency of borrowing or applicable benchmark

Interest payment schedule, principal repayment schedule, drawdown schedule

are also to be mentioned in this application form. Besides this any change in

above should be reported by filing revised form 83 through AD within 7 days of

such change. After due verification Reserve bank of India allot LRN no. Borrower

has to use this LRN no for all future correspondence, for change, addition,

reduction of loan.

Format of Form 83

DRAFTFORM

83.docx

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Average Maturity Period :

Borrower has to comply with average maturity period of minimum 3 years for any

change in drawdown, reduction in loan, this can be verified through calculation as

per given below illustration.

Loan Amount USD 3400000

Date of drawal / Repayment

(MM/DD/YYYY) Drawal Repayment Balance

No. of

Days **

balance

with the

borrower

Product =

( Col 4 * Col

5) / (loan

amount *

360 )

Column 1 Column 2 Column 3 Column 4 Column 5 Column 6

28/09/12 1694500 1694500.00 30 0.0415

28/10/12 965100 2659600.00 30 0.0652

28/11/12 191200 2850800.00 30 0.0699

28/12/12 291300 3142100.00 30 0.0770

28/01/13 38200.00 3180300.00 60 0.1559

28/03/13 219700.00 3400000.00 1619 4.4972

27/09/17 3400000.00 0.00 0.0000

Average Maturity 4.9067

** Calculated by = DAYS360(firstdate,seconddate,360)

Borrower needs to submit monthly return to reserve bank of India through AD in

form ECB2, on monthly basis, within 7 working days of end of every month,

reporting all transactions during the month.

Why ECB Loan preferred by MNCs over local loan types.

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At present PLR (prime lending rate) or Base Rate is more than 8% in India, All

banks are lending to corporate and business institutions over and above this PLR

/BR depending on rating or assessment of that corporate and business

institutions, even for A+ rated corporate and business institutions interest rates

are more than 8-9% per annum for long term borrowing, more so in India Inflation

rate is higher, ECB loan from Foreign institutions, Private lenders allows these

Indian Counterparts of corporate and business institutions to borrow funds at 6

months LIBOR + Max 350 basis Points, which comes less than 6% as per

present rate. Therefore ECB loan is preferred over local borrowing or debt loans.

Given below is chart showing 6 months USD LIBOR rate on quarterly basis since

2005.

Date USD 6 Months LIBOR Rate Date USD 6 Months LIBOR Rate

29/12/2004 2.7750 26/12/2008 1.8113

29/03/2005 3.3800 28/06/2009 1.0950

28/06/2005 3.6600 28/09/2009 0.6388

28/09/2005 4.2000 29/12/2009 0.4340

28/12/2005 4.6900 29/03/2010 0.4425

29/03/2006 5.1100 28/06/2010 0.7472

28/06/2006 5.6175 28/09/2010 0.4625

27/09/2006 5.3719 29/12/2010 0.4569

27/12/2006 5.3606 29/03/2011 0.4605

28/03/2007 5.3238 28/06/2011 0.4008

27/06/2007 5.3750 28/09/2011 0.5484

29/09/2007 5.1325 29/12/2011 0.8085

27/12/2007 4.7175 29/03/2012 0.7343

27/03/2008 2.6325 28/06/2012 0.7344

26/06/2008 3.1338 28/09/2012 0.6359

26/09/2008 3.8763 29/12/2012 0.5083

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Six Month Libor History ( 6 Month Libor)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2012 0.809 0.778 0.749 0.733 0.748

2011 0.456 0.454 464 0.460 0.431 0.403 0.398 0.430 0.486 0.558 0.619 0.748

2010 0.430 0.384 0.387 0.444 0.531 0.752 0.753 0.668 0.497 0.463 0.448 0.461

2009 1.750 1.660 1.803 1.736 1.565 1.240 1.111 0.925 0.755 0.629 0.564 0.488

2008 4.596 3.041 2.931 2.614 2.965 2.911 3.109 3.084 3.118 3.981 3.121 2.591

2007 5.401 5.372 5.321 5.358 5.384 5.381 5.386 5.327 5.535 5.133 4.806 4.910

2006 4.813 4.991 5.120 5.288 5.322 5.639 5.547 5.450 5.370 5.390 5.350 5.365

2005 2.958 3.1495 3.388 3.415 3.531 3.691 3.924 4.082 4.215 4.447 4.580 4.690

2004 1.211 1.203 1.160 1.368 1.579 1.942 1.986 1.991 2.170 2.301 2.624 2.775

2003 1.353 1.336 1.262 1.290 1.223 1.124 1.151 1.210 1.180 1.221 1.230 1.219

2002 1.989 2.068 2.332 2.100 2.090 1.948 1.863 1.815 1.751 1.618 1.471 1.383

2001 5.361 4.955 4.711 4.231 3.990 3.827 3.694 3.479 2.532 2.173 2.101 1.9832000 6.238 6.328 6.530 6.614 7.064 7.014 6.887 6.831 6.761 6.721 6.678 6.208

1999 5.036 5.168 5.083 5.075 5.193 5.633 5.680 5.913 5.974 6.144 6.063 6.136

(Source: http://www.erate.com/six_month_libor_index.6-months-libor.htm)

Upon going through above rate table it is confirmed that ECB loan interest is

lower, and therefore it is viable to go for these loans wherever possible. However

borrower should comply with all requirements and also follow all rules and

regulations of FEMA, and adhere to RBI guidelines to avoid compounding

proceedings.

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BUYERS CREDIT

INTRODUCTION

Buyers Credit refers to loans for payment of imports into India arranged on

behalf of the importer through an overseas bank. The offshore branch credits the

nostro of the bank in India and the Indian bank uses the funds and makes the

payment to the exporter bank as an import bill payment on due date. The

importer reflects the buyers credit as a loan on the balance sheet.

Benefits of Buyers Credit:

The benefits of buyers credit for the importer is as follows:

The exporter gets paid on due date; whereas importer gets extended date for

making an import payment as per the cash flows.

The importer can deal with exporter on sight basis, negotiate a better discount

and use the buyers credit route to avail financing.

The funding currency can be in any FCY (USD, GBP, EURO, JPY etc.)

depending on the choice of the customer.

The importer can use this financing for any form of trade viz. open account,

collections, or LCs.

The currency of imports can be different from the funding currency, which

enables importers to take a favourable view of a particular currency.

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Buyers Credit Process flow:

1. Indian customer imports the goods either under DC / LC, DA / DP or Direct

Documents.

2. Indian customer requests the Buyers Credit Consultant before the due date of

the bill to avail buyers credit finance.

3. Consultant approaches overseas bank for indicative pricing, which is further

quoted to Importer.

4. If pricing is acceptable to importer, overseas bank issues offer letter in the

name of the Importer.

5. Importer approaches his existing bank to get letter of undertaking / comfort

(LOU / LOC) issued in favour of overseas bank via swift.

6. On receipt of LOU / LOC, Overseas Bank funds existing banks Nostro

account for the required amount

7. Existing bank to make import bill payment by utilizing the amount credited (if

the borrowing currency is different from the currency of Imports then a cross

currency contract is utilized to effect the import payment)

8. On due date existing bank to recover the principal and Interest amount from

the importer and remit the same to Overseas Bank on due date.

Cost Involved:

The cost involved in buyers credit is as follows:

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Interest cost: This is charged by overseas bank as a financing cost. Normally it

is quoted as say 3M L + 350 bps, where 3M is 3 Month, L is LIBOR, & bps is

Basis Points (A unit that is equal to 1/100th of 1%).

To put is simply: 3M L + 3.50%. One should also check on what tenure LIBOR is

used, as depending on tenure LIBOR will change. For example as on day, 3

month LIBOR is 0.33561% and 6 Month LIBOR is 0.50161%

Letter of Comfort / Undertaking: Your existing bank would charge this cost for

issuing letter of comfort / Undertaking

Forward / Hedging Cost

Arrangement fee: Charged by Buyers Credit Agents / Brokers how is arranging

buyers credit for you.

Other charges: A2 payment on maturity, For 15CA and 15CB on maturity,

Intermediary bank charges etc.

Withholding Tax(WHT): The customer has to pay WHT on the interest amount

remitted overseas to the Indian tax authorities.

Regulatory Framework:

RBI has issued directions under Sec 10(4) and Sec 11(1) of the Foreign

Exchange Management Act, 1999, stating that authorised dealers may approve

proposals received (in Form ECB) for short-term credit for financing by way of

either suppliers credit or buyers credit of import of goods into India, based on

uniform criteria.

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Over the years there has been changes in norms. Current norm as per RBI

Master Circular on External Commercial Borrowing (ECB) and Trade

Finance 2011 are

A. Amount and Maturity

Maximum Amount Per transaction : $20 Million Maximum Maturity in case of

import of non capital goods: upto 1 year from the date of shipment

Maximum Maturity in case of import of capital goods : upto 3 years from

the date of shipment

B. All-in-cost Ceilings

Upto 1 year : 6 Month Libor + 350 bps *

Upto 3 years : 6 Month Libor + 350 bps *

All applications for short-term credit exceeding $20 million for any import

transaction are to be forwarded to

the Chief General Manager, Exchange Control Department, Reserve Bank of

India, Central Office, External

commercial Borrowing (ECB) Division, Mumbai.

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CASE STUDY- AN MNC- Manufacturing of Calcium Carbonate

The name of Company is not been mentioned due to Company Policy of not

using name any ware without board of directors permission. Therefore for this

project purpose the name used as ABC Company

ABC company is MNC closed privately held Switzerland based Company, this

company has decided to enter into India with manufacturing plant after seeing

overall growth for their products in India, company had planning of expanding its

activities, therefore studied various options for long term funding.

The borrowing in India through commercial banks was costing around 12-13%

p.a. Company has then informed by local Finance team about other option of

ECB-Commercial loan through which Private lender can finance Indian company

upon satisfying following conditions as given below.

1] Recognized lender

Borrowers can raise ECB from internationally recognized sources, such as (a)

international banks, (b) international capital markets, (c) multilateral financial

institutions (such as IFC, ADB, CDC, etc.) / regional financial institutions and

Government owned development financial institutions, (d) export credit agencies,

(e) suppliers of equipments, (f) foreign collaborators and (g) foreign equity

h o l d e r s [ o t h e r t h a n e r s t w h i l e O v e r s e a s C o r p o r a t e B o

d i e s ( O C B s ) ] . Companies registered under Section 25 of the

Companies Act,1956 and are engaged in micro finance will be permitted to

avail of ECBs from international


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banks, multilateral financial institutions, export credit agencies, foreign equity

holders, overseas organizations and individuals. A "foreign equity holder" to be

eligible as recognized lender under the automatic route would require minimum

holdin g of paid-up equ it y in the borro wer compan y a s se t out

belo w: (i) For ECB up to USD 5 million - minimum paid-up equity of 25 per

cent held directly by the lender,

(ii) For ECB more than USD 5 million - minimum paid-up equity of 25 per cent

held directly by the lender and ECB liability-equity ratio not exceeding 4:1

Besides the paid-up capital, free reserves (including the share premium received

in foreign currency) as per the latest audited balance sheet shall be reckoned for

the purpose of calculating the equity of the foreign equity holder in the term ECB

liability-equity ratio. Where there are more than one foreign equity holder in the

borrowing company, the portion of the share premium in foreign currency brought

in by the lender(s) concerned shall only be considered for calculating the ECB

l i a b i l i t y - e q u i t y r a t i o f o r r e c k o n i n g q u a n t u m o f p e r m i

s s i b l e E C B . For calculating the ECB liability, not only the proposed

borrowing but also the outstanding ECB from the same foreign equity holder

lender shall be reckoned. Overseas organizations and individuals providing

ECB need to comply with the following safeguards:

(i) Overseas Organizations proposing to lend ECB would have to furnish to

the AD bank of the borrower a certificate of due diligence from an overseas bank,

which, in turn, is subject to regulation of host-country regulator and adheres to

the Financial Action Task Force (FATF) guidelines. The certificate of due

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diligence should comprise the following (i) that the lender maintains an account

with the bank for at least a period of two years, (ii) that the lending entity is

organised as per the local laws and held in good esteem by the business/local

community and (iii) that there is no criminal action pending against it.

Since the company is 100% foreign share holding company, ECB liability-equity

ratio not exceeding 4:1, company could enter into agreement with overseas

foreign collaborator. This would enable overseas MNC company finance the its

Indian counterpart ABC Company at much lower rate, and thereby lowest cost of

borrowing, which will make ABC company more competent due to lower cost.

ABC Company since then started 2 more projects by using ECB loan financing

and able to establish itself in a very completive Indian business environment.

However due all its raw material sources are from outside india, also the

business, was more of volume nature, it started facing working capital crunch,

again the finance team found solution in buyers credit facility. Company has

started using Buyers credit facility instead of Overdraft/Cash credit facility. The

comparison of savings after using buyers credit facility are shown given below.

Rate at which Overdraft facility available to the company 12%

Import

Shipment

Average time of

Business Cycle

Interest expenses if

used through OD/CC

Interest expenses if used

through OD/CC

USD

1000000

90-105 days 12% USD3MLIBOR+275BPS+W/h

Tax+TelexChgs+Certification

Chgs

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Effective rate 12% 3.12% +USD 25 Telex

Chgs+INR 2000

Total In Rs if

Fx rate @54

for 90 days

15,97,808 4,18,780

Therefore Saving of more than Rs.10 lakhs for this transaction

Average time of Business Cycle : This is time taken by company from sourcing of

raw material, converting into finished goods, sales, collection.

Caution:

However as this transaction involves foreign currency there is always risk for

exchange fluctuation, and to cover these risk, forward contract or with or without

option can be entered into.

FINDINGS FROM CASE STUDY

From the above case study, we can see that ECB is one of the best source for

MNCs and other Business institutions for availing finance at lowest interest rate

in india, and enjoying the Interest parity benefit. Also by using Buyers Credit one

can solve the problem of high cost of working capital. Though there is always risk

of exchange fluctuation in long run due to open market, demand and supply

factors play important role.

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SUGGESTIONS, RECOMMENDATIONS AND CONCLUSION

1. The liquidity position of the company by using buyers credit can be utilized

in a better or other effective purpose.

2. The company can be use the extended credit facilities by using Buyers

credit by rolling over 90 days credit to further period till 365 days, thereby

can save itself in extreme adverse situations.

3. In India due to high rate of inflation, local borrowing cost always be on

higher side than from foreign borrowing through ECB.

4. Efforts should be taken to increase the overall efficiency in return out of

working capital employed by making used of the available resource

effectively.

5. The company can increase its sources of funds to make effective research

and development system for more profits in the years to come.

LIMITATIONS AND SCOPE FOR FURTHER STUDY

As the study is based on secondary data, the inherent limitation of the

secondary data would have affected the study.

The rates taken in examples are likely to be a changes as per market demand

& supply, and so might not give a proper indication in future market environment.

This study need to be interpreted carefully. They can provide clues to the

companys performance or financial situation. But on their own, they cannot show

whether performance is good or bad. It requires some quantitative information for

an informed analysis to be made.

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BIBLOGRAPHY

Websites:

http://en.wikipedia.org/wiki/External_Commercial_Borrowing

http://www.rbi.org.in/

http://www.homefinance.nl/english/international-interest-rate s/libor/usdollar/libor-

rates-6-months-usd.asp

http://www.erate.com/six_month_libor_index.6-months-libor.htm

http://www.bbalibor.com/
http://en.wikipedia.org/wiki/External_Commercial_Borrowinghttp://www.rbi.org.in/http://www.homefinance.nl/english/international-interest-rates/libor/usdollar/libor-http://www.homefinance.nl/english/international-interest-rates/libor/usdollar/libor-http://www.erate.com/six_month_libor_index.6-months-libor.htmhttp://www.bbalibor.com/http://en.wikipedia.org/wiki/External_Commercial_Borrowinghttp://www.rbi.org.in/http://www.homefinance.nl/english/international-interest-rates/libor/usdollar/libor-http://www.erate.com/six_month_libor_index.6-months-libor.htmhttp://www.bbalibor.com/

External Commercial Borrowings Shaik Majid

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