Demystifying ECBs
India Inc. must tap foreign funds with caution
External Commercial Borrowing (ECB) is a cheap
source of financing for India Inc due to the interest rate differential between
India and the capital surplus overseas markets such as the US and Euro Zone
countries. It helps bring down the cost of financing for Indian enterprises.
However, borrowers should be aware of the risks associated with this form of
financing as any adverse currency movement at the time of redemption of ECB
could singe them.
What this means is that if the underlying exposure
is not hedged and the rupee depreciates vis-a-vis the
currency in which the borrowing is denominated, the borrower will come to
grief.
Ashutosh Raravikar, Director, Department of
Economic Policy & Research (DEPR), RBI, shines light on such risks and
demystifies ECBs in his latest book — India’s
External Commercial Borrowing: Features, Trends, Policy and Issues.
Financing
costs
The author builds the narrative on
ECBs over five chapters — The Conceptual Framework, The Journey of ECB in
India, Evolution of India’s ECB Policy, Empirical Studies, and India’s External
Debt Management: Issues and Policy Prescriptions — in easy to understand
language. He has also provided many charts and tables to complement the
narrative. Raravikar has underscored the fact that ECB, which is a commercial
loan raised by an eligible resident entity from recognised non-resident
entities, is a double-edged weapon and it boils down to the borrowers’ skill to
use it to their advantage.
With interest rates in the US and Euro
Zone currently being markedly lower than domestic rates, a corporate can save
on its financing costs by taking recourse to ECB even after it takes into
account associated costs such as hedging, guarantee fees and other transaction
costs.
But then, the author also warns of the
temptation to borrow excessively due to cheaper access to funds as this could
adversely impact the borrower’s financial position due to exchange rate risk
(if the tide turns) involved in servicing the debt. Hedging involves costs and
this option may not be always available.
Commercial borrowings account for the
largest component of India’s external debt. The author observed that higher
magnitude of foreign debt could lead to rupee appreciation and reduction in the
competitiveness of our exports. Hence, keeping the debt within limit keeps
exports competitive and promotes export growth.
The author mentions that the six-month
London Interbank Offered Rate (LIBOR) or any other six-month interbank interest
rate applicable to a currency of borrowing such as Euro Interbank Offered Rate
is the benchmark rate for ECBs in foreign currencies.
Raravikar opines that when it is not
possible for the central bank of the country to allow high level of liquidity
during inflation times, ECB is the best solution to push productive lending
without implications for price rise. The author also gives valuable
suggestions. He says the ECB framework should minimise the necessity for
borrowers to have manual interaction with regulators. This would facilitate the
business environment. In the context of domestic banks facing impending rise in
bad loans and also becoming risk averse in lending, overseas borrowing can
supplement this credit gap.
With the ECB market for some
borrowers, whose rating was adversely impacted during the pandemic period,
diminishing, Raravikar argues in favour of fresh policy measures, including
upward revision in all-in-cost ceiling. This will help finance India’s growth
needs. This book can be useful for entrepreneurs, CFOs, company officials
responsible for mobilising resources, and MBA students, among others.
The author could consider including a
small note on the global transition from LIBOR to the emerging benchmark
(Secured Overnight Financing Rate) and its impact on ECBs when the book goes
into a second edition.
Source | Business Line | 15th February 2021
Regards!
Librarian
Rizvi
Institute of Management
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