BALANCING GROWTH AND RISK: INDIA’S APPROACH TO EXTERNAL COMMERCIAL BORROWINGS BY - DANISH HUSAIN & SONALI SINGH
BALANCING GROWTH AND RISK: INDIA’S
APPROACH TO EXTERNAL COMMERCIAL BORROWINGS
AUTHORED BY - DANISH
HUSAIN & SONALI SINGH
INTRODUCTION
As
competition increases and the complexity of the international financial
structure advances, ECBs have emerged as an effective way to fund business
operations and governmental projects, especially in developing countries such
as India. Coordinated through the ECB system, Indian corporations, public
sector firms, and other qualifying parties can obtain financing from global
capital markets at possibly reduced interest expense as compared to domestic
funding. This mechanism is most effective in the large end-use sectors like
infrastructure, manufacturing, and energy that need a large initial outlay.
ECBs have been most useful for countries like India for meeting financing needs
where infrastructure creation is necessary for long-term sustainable growth. Besides,
if the interest rates suggest so, ECBs also contribute to increasing the
integration of India into the global economy by attracting foreign investments.
However,
as this paper demonstrates, ECBs bear certain vulnerabilities to India’s
financial sector, especially vis-à-vis the fluctuations in foreign currency and
the issues of dealing with external liabilities. India over time has put in
place a legal structure to contain this risk while encouraging capital inflows.
Key regulatory authorities embracing ECBs include the Reserve Bank of India
(RBI) and the Securities Exchange Board of India (SEBI) have played an
important role in policy making on ECBs. With the country still relying on
external borrowings, there is a need to balance the search for foreign
investments and economic security.
EVOLUTION
External
Commercial borrowing has been well associated with the liberalization of the
Indian economy and globalization process. Before 1991, India’s economy has been
more of a reserved economy with stringent control measures on foreign funds.
There was concern about external borrowing burdens labeled by high external
debts, fluctuating exchange rates, and difficulties in Forex. Hence, facilities
for drawing global funds and credit from overseas markets were severely limited
under strict regulatory measures.
The early 1991 is considered the landmark period when the country initiated the
process of liberalizing the economy. The formation of liberalization policies
was related to the Balance of payments (BOP) situation in India and became an
important component of these policies. The government saw that borrowings from
different international markets are useful in financing infrastructures and
broadening the industrial structure.
This change of stance was conducive to the successive changes in the regulatory
framework of the ECB over time.
PHASES OF EVOLUTION
- Post-War Era
and the Bretton Woods System (1940s-1970s):
After
World War II, the world’s financial system was reconstructed with the system of
Bretton Woods, in accordance with which the International Monetary Fund and
World Bank were created. This framework laid the foundation for borrowing and
lending across the borders activities.
Application:
Emerging markets started borrowing from foreigners to rebuild their economies
and investment funds; globally, most funds were borrowed from international
financial institutions as against borrowing from individuals. For developing
countries such as India, the opportunity to get foreign capital was considerably
scarce. Earlier, only a handful of the large public sector enterprises or
government agencies could borrow from international markets.
An emphasis was placed on official development assistance and bilateral or
multilateral financing.
Regulatory
controls: Due to issues to do with foreign exchange reserves and sustainability
of debt, there were strict limitations to foreign borrowings. Since the 1990s,
the Indian companies involved in corporate borrowings from global sources of
funds have gotten a boost due to the policy liberalization on external
borrowings, moving towards capital accounting and more enhanced credit ratings.
During this particular period, a country's problem was the balance of payments
(BOP), especially in the deterioration of non-oil import payments, capital
inflow through external aid, and private borrowings for commercial purposes.
The Total Financial requirements of the country in 1985 were fulfilled by ECBs
to the extent of one-fourth.
However, since 1991 for different reasons of a shift in government policy from
debt to non-debt financial flows, the prominence of ECBs gradually declined.
2. Liberalization
and growth (1990s to early 2000s)
During
the period in the early decade, particularly the 1990, the economies of the world
especially of developing nations such as India expanded immensely with the
liberalization of their economy. During this period, there was increased usage
of ECBs occasioned by the need to tap new opportunities in business.
Deregulations:
It also became easier for businesses to source funds internationally due to the
changes in the regulatory framework. Over the years all the countries slowly
began to ease general restrictions on the volume, the maturity, and the
utilization of ECBs.
Diverse
Borrowing Sources: Firms started searching for various mechanisms for ECBs such
as syndicated loans, bonds, and so forth. On one side liberalization,
privatization, and globalization since 1991 have sacked Developmental Financial
Institutions (DFIs) on the other side it compelled corporate houses to go for
huge External Commercial Borrowers (ECBs). In this method Developmental Finance
institutions which were formed to help industries were given authority to give
loans to long-term industries at subsidized rates of IFCI, IDBI, ICIC, and
SFCs. However, with the liberalization of ECB policy, a new low-cost financing
opportunity was made available to firms. Due to this corporate sector borrows
from global institutions who were willing to take risks and offer cheaper funds
than costly domestic funds available.
3. Global
Financial Crisis and Regulation (2008-2010)
Considering
the global financial crisis there was, therefore, a change in credit markets.
That affected the supply and the price of ECBs to business entities most of
which were operating in the emergent markets. Banks especially those in
government-setting countries stepped up supervision as a means of controlling
risks emanating from ECBs.
To achieve this, it entails checking the level of external debt and the amount
of borrowing from the outside world. The trends of ECBs depict that for the
years 1991-92 and 1992-93 the gross ECB inflow has reduced and has a negative
figure in the later year. Business in emerging markets. Regulatory Responses:
Governments and central banks increased oversight to manage risks associated
with ECBs. This included monitoring the levels of external debt and
implementing stricter borrowing guidelines.
The
shift of ECBs clearly shows that the size of total ECB inflows in India reduced
mainly in the years 1991 to 1992 and 1992 to 1993 and became negative in the
later years. It then increased at a rapid pace until 1996 and 1997 as a result
of policy liberalization, such as expanding business borrowing options abroad.
Bank borrowings, trade-related credits, and the flow through convertible bond
placements in the offshore market all increased during this time. India's
capital account saw a sharp decline from 1997 to 2001 due to several factors,
these factors included the East Asian currency crisis, Argentina's default on
its international bond obligations, the Iraq war, high credit market
volatility, low investor confidence, and extreme risk aversion.
4. Post-crisis
period and market maturity (2010 present)
More
effectively, the global financial process makes emerging markets more
integrated into the financing process; companies can use more Broder range of
financing techniques, green bonds, and masala bonds (rupee-denominated bonds
issued outside India). Greater attention was paid to managing currency risks
Risk Management associated with ECBs and increased hedging with the help of derivatives.
International institutions such as the Reserve Bank of India from time to time
were updating their ECB frameworks due to the tension between capital demand
and the stability of the financial system. These measures included limiting the
uses of the funds for productivity only and promoting longer-term borrowing
over short-term borrowing. It can be seen from the trends of the ECB that the
amount of gross ECB inflows into India for 1991–92, 1992– 93, and 1993– 94
formed the trough as they turned negative in the latter year-end bonds and
masala bond (rupee-denominated bonds issued outside India). There was a
stronger focus on managing currency risks Risk Management associated with ECBs,
leading to more hedging and use of derivatives. Central banks such as the
Reserve Bank of India periodically updated their ECB frameworks to balance the
need for capital inflows with the need to maintain financial stability.
This included measures like restricting end uses to productive purposes and
encouraging long-term borrowing over short-term loans, The trends of ECBs show
that the amount of gross ECB inflows in India declined during the years 1991-92
and 1992-93 and became negative in the later years. It has been growing at a
steady rate till 1996-97 it is partly because of liberalization policies such
as raising the ambit for overseas borrowings by corporates. There was a marked
rise in the trade-related credits, bank loans, and convertible bonds floated in
the Euro market.
Current
trends
With
increasing focus on sustainability, more and more businesses are issuing ECBs
through green bonds and other securities that are related to environment,
social, and governance. ESGs Fintech and Different digital platforms have
enhanced the ease of companies in tapping the credit markets internationally to
environments linked to environmental, social, and governance (ESGs) criteria.
Advances in fintech and digital platforms have made it easier for companies to
access international credit markets. The outbreak of the COVID-19 pandemic and
geopolitical tension have an influence on global financial products including
the ECBS.
The
historical background of ECBs in India can be obtained from the Sahoo Committee
Report tabled in the Indian Parliament in 2015.
First, until the early 1980s, India’s utilization of the global capital markets
was relatively small, so more domestically owned companies relied on a
bilateral and multilateral approach for external financing. Nonetheless, with
the liberalizations of the 1990s onwards, India adopted more open policies to
cover external finance which led to a sharp rise in ECBs as Indian firms looked
forward to international capital markets for expansion. The Sahoo Committee
pointed out the imperative to establish an effective framework to govern the
risks that are tied to ECBs including currency risk. They noted that there
should be changes to financial regulation that correct market inefficiencies
but not developmental ones.
With
the emergence of liberalization policy in the 1990s, India began allowing
foreign capital to fund its expanding financial needs. Nonetheless, open-outcry
ECBs posed threats to India’s external debt profile, foreign exchange, and the
country’s soundness of financial systems. Measures have been taken to mitigate
these risks and to regulate these FDI flows more effectively, RBI used a route
system for ECB. One is the Automatic route and the other one is the approval
route. The Automatic Route allowed Indian businesses to access ECBs without
prior government or RBI clearance if they complied with certain regulatory
parameters that included borrowing Limits, End-Use Restrictions, and Borrower
Eligibility. This route was to gain more foreign capital in the country,
particularly for some companies by doing away with many formalities. In aim,
the Approval Route insisted on prior RBI approval before companies could access
ECBs. This route was for situations where companies required ECBs beyond the
normative prescribed framework, and particularly where the sector or the borrowing
conditions are relatively high risk. Although the procedure required RBI’s
supervision, it was easier to monitor loans in sensitive sectors or beyond the
normative levels of borrowing, thereby implying a higher level of financial
stability.
Process
of raising ECB
The
concept of raising foreign resources involves the steps through which Indian
companies can obtain ECBs from foreign lenders. This process includes meeting
regulatory standards set by the Reserve Bank of India (RBI) under two distinct
categories:
There are two types of routes: The Automatic Route, and the Approval Route. They
also have their eligibility, procedural, and compliance steps with a view to
regulating the admission of foreign capital in India while protecting the country’s
financial opening.
Approval
Route
As
per the Approval Route for the ECBs, the companies belonging to some sectors or
fulfilling some qualitative criteria need prior approval of the government or
RBI each time to raise money. These are imposed on companies to regulate
higher-risk industries or conditions that need more control in attaining
economic objectives and under the regulation of the business government.
Qualifying parties under this approach are the EXIM bank for on-balance
funding; and the banking and financial sectors that are participating in
implementing sector-focused receivables restructuring for industry, such as
textile and steel, with government of India and RBI approval. Non-Banking
Financial Companies (NBFCs) also fall into this route when taking funds from
multilateral financial institutions with a minimum five-year tenor if
classified as Infrastructure Finance Companies by the RBI. Further, housing
finance companies can raise ECBs through Foreign Currency Convertible Bonds
(FCCBs) if they meet stringent conditions: the financial intermediary raising
funds should have a net worth of INR 500 crores and more and it should be a
listed company in NSE or BSE and FCCB up to USD 100 million should be issued by
the company where the purpose of fund utilization should be pre-approved. Also,
SEZ developers who primarily concentrate on infrastructure facilities and
various corporates involved in the service sector like hotels, hospitals, and
software companies needed to deal with the ECBs of more than USD 200 million in
terms of Approval Route.
Where
ECBs are raised from indirect equity holders, the Approval Route is required
where the lender has more than 51% indirect equity in the Indian company. Those
Corporates involved in ECB-related violations with the RBI, or the Enforcement
Directorate (ED) also require the Approval Route. This route is
all-encompassing of any ECB proposals that do not for in the Automatic Route
while guaranteeing their assessment to ensure they meet all the regulatory requirements.
Automatic
Route
According
to the automatic route, no governmental prior approval is needed by the
entities that intend to raise borrowings. Instead, they have to follow certain
laid down conditions like maximum allowable borrows, industry categories, and
uses of the funds. Those companies that satisfy these conditions are free to
launch funds on their own through the automatic route without the government’s
approval.
The
type of borrowers allowed to obtain ECBs in India are companies incorporated
under the Indian Companies Act of 1956, including banks and other financial
institutions, hotels, hospitals, infrastructure companies, micro-finance
institutions (MFIs), and units in Special Economic Zones (SEZs) through the
automatic route. However, ECBs cannot be raised through this route by
individuals, trusts, and nonprofit organizations. Identified lenders consist of
multilateral development banks, international commercial banks, official export
credit agencies, overseas equity investors, international capital markets, and
overseas partners. For foreign equity holders, specific requirements apply they
must have at least 25 % of the paid-up capital in the borrowing company for
loans that do not exceed USD 5 million, and the same condition applies for
loans that exceed this amount. Additionally, the debt-to-equity ratio should
not exceed 4:1. All these criteria are useful in making the ECB more effective
while at the same time maintaining a good balance of foreign borrowing.
According
to ECB guidelines in India, other industries can borrow up to $750 million a
year while the hotel industries, healthcare industries, and software industries
can borrow up to $200 million which cannot be used for land purchases.
Concerning the above sources microfinance-focused NGOs and other microfinance
institutions can mobilize up to $10 million a year. Additionally, ECBs have a
minimum maturity period requirement based on the loan amount: for loans not
exceeding $20 million, the minimum tenor is three years for loans not exceeding
$750 million the minimum tenor is five years. This rule enables assured foreign
funds management by various companies and, inclusive, time frames for
repayments.
GOVERNING ACTS AND REGULATION OF ECBs
External
Commercial Borrowings (ECBs) are credit funds raised by an Indian Company, in a
foreign currency from a non-Indian source. The intent of such borrowings could
be to finance different corporate and infrastructure programs, and so on. The
guidelines and rules to control ECBs are at large determined by the Reserve
Bank of India (RBI) and are intended to avoid the adverse consequences of these
borrowings on the Indian economy.
Transition
from FERA to FEMA
The
earlier legal architecture of the FERA was substituted with FEMA which brought
about a change from the earlier control-based approach post-liberalization to a
more positive growth-friendly regulatory regime prevalent in India. This
transformation was required to achieve a more efficient foreign exchange
control that would be suitable for the liberalized economy, especially after
the 1991 crisis. FEMA planned to encourage exports and investment while at the
same time promoting structured growth of the foreign exchange market. As India
began liberalizing its economy there emerged a requirement to have FDI,
especially through External Commercial Borrowings (ECBs) in large projects.
However, such borrowing practices put organisations in perilous situations such
as fluctuations in currency prices meaning that they require a proper framework
to regulate these risks to avoid financial imbalance. The various measures
enumerated under FEMA were aimed at maintaining the finest balance between
economic liberalization and monetary stability where quantity and employment of
borrowings from foreign territories were capped and the eventual usage was
directed to be most productive and in sync with Indian economic goals. Further,
the regulations were intended for the preservation of India’s foreign exchange
reserves and for the growth of the financial markets where the domestic markets
are linked with the global markets.
These regulations also promoted investment in other strategic areas and
nurtured export-oriented industries which in the long run boosted economic
growth, by providing access to foreign capital.
Regulatory
Acts Governing External Commercial Borrowings in India
Foreign
Exchange Management Act (FEMA), 1999
FEMA
is the primary law that regulates external financial business in India and
comprises ECBs. In FEMA, the power to control the inflows as well as outflows
of foreign exchange has been vested with the RBI. ECBs are regulated through
FEMA, particularly to the rules regulations, and guidelines notified by the RBI
under the FEMA Act. Section 6(2) of FEMA, 1999
is very important to regulate ECBs in India because it acts as a framework to
regulate ECBs. Section 6(2) FEMA
therefore bestows on the RBI the appellate jurisdiction about borrowing or
lending in foreign exchange, transfer of foreign exchange, or making any
payment to or receipt of payment for import, from any person who is a resident
outside India. This section provides the RBI with the authority to impose
precautionary measures regarding the kinds of transactions and how they must be
done.
Under
section 6(2), the RBI is further empowered to develop the regulation relative
to the ECB. These consist of conditions such as eligible borrowers, recognized
lenders, the permissible end use, all-in cost ceilings, and other special
features that borrowers must meet. For example, under the powers conferred by
this section, the RBI has issued Master Directions or circulars on ECBs laying
down guidelines and rules for such borrowings to ensure their conformity with
India’s macroeconomic policies and management of forex affairs.
According
to Section 6(2)(c),
the RBI has power over the borrowing of funds in foreign exchange and hence
directly imparts to ECBs. ECBs are thus loans availed of by entities in India
from party foreign creditors and hence come under this section.
In
conclusion to this section, Section 6(2) FEMA, 1999 is a key provision needed to
enable the Reserve Bank of India to regulate ECBs. It offers the legal
mechanisms that RBI can use to oversee the borrowing and lending in foreign
exchange in a way that is productive and secure for India’s economy.
Foreign
Exchange Management (Guarantees) Regulations, 2000
The
Foreign Exchange Management (Guarantees) Regulations, 2000
stated the various guidelines in respect of guarantees for Indian as well as
foreign persons. These rules are broader than one might think, covering any
case where a guarantee might extend to the financial assets or liabilities of a
person or an entity in a foreign country. As prescribed by FEMA, most trading
transactions that are normal in any economy are permitted, but capital
transactions are allowed only if they are out of the FEMA purview. This is so
because capital transactions can influence the balance character of individuals
and units within India and outside India.
Hence,
all such transactions which are made by an Indian resident or non-resident
resulting in a change (enhancement or reduction) of his/her assets or
liabilities shall fall within this section. Notwithstanding the provisions
contained in Section 6 (1)
and under such permissible class of transactions and limit of forex, as may be
notified by the RBI, the Act contains general permission that any person may
sell or draw foreign exchange to or from an authorized person for any capital
account transaction.
According
to Section 6 (3)(j)
read with Section 47 of the FEMA,
the powers of the Reserve Bank of India to issue the Foreign Exchange
Management (Guarantees) Regulations 2000 and the Foreign Exchange Management
(Permissible capital account transactions) Regulations 2000 to regulate giving
of guarantee.
The
provision of Regulation 3 of the Foreign Exchange Management (Guarantees)
Regulation 2000
lays down the conditions under which an Indian resident may give a guarantee in
favor of a non-resident in as much as he is permitted and notified or only in
so far as it is covered by the general or special permission of the RBI.
Prohibition
in the Regulations: Foreign Exchange Management (Guarantees) Regulation, 2000,
Regulation 3, provides a blanket prohibition on the granting of the following
in terms of part sponsoring of guarantee save for general or special permission
of the RBI.
•
Giving of any guarantee
•
Provision of any surety
•
Any other transaction
that has the same impact as guaranteeing a debt, obligation, or any other liability
of an individual who is resident in India or of an individual who has borrowed,
such sum from an individual residing outside India. The above are prohibited
when provided by a resident, to a non-resident. If the guarantor is personally
a resident of India and the debtor is a non-resident, then the Regulations
apply. In other words, the same Regulations will apply irrespective of whether
the person in respect of whom the guarantee is given is a resident or not.
IMPACT OF ECB ON THE INDIAN ECONOMY
ECBs
play an important role in the Indian economy as an external source of funds for
many sectors resembling as important sources of foreign capital. The above
borrowings assist in fulfilling the financial needs of Indian companies
especially in infrastructure, manufacturing, and other capital-intensive
industries. ECBs help mobilize foreign investments to boost the economic level,
increase the competence of a country in the world, and aid the flow of funds to
be available at reasonable interest rates. Also, they enable the overcoming of
the domestic savings-investment gap, thus contributing to development.
Nonetheless, the high usage of ECBs may surprisingly lead to issues on foreign
debt indicators as well as apprehension over the resilience to foreign economic
disturbances calling for effective regulation and supervision of such
facilities.
Advantages
of External Commercial Borrowings (ECBs) include lower interest rates compared
to the cost of domestic sources of financing, which therefore makes it cheaper
for corporations. They are financed in foreign currency so that helps
organizations for instance to import machinery or pay international suppliers.
They also enable businesses to issue large funds for long-term requirements
such as infrastructure, from internationally accredited places like the capital
markets and banks.
Indian
companies' registrations for external commercial borrowings (ECBs) surged
nearly twofold at $49. Meanwhile, the overall cost of ECB loans rose in FY24 to
USD 72 billion from USD 62.3 billion last fiscal year owing to high global
benchmark interest rates, but net inflow saw an improvement at $9.5 billion.
FY23 net ECBs to India flew in at under $1 billion. Last year, the EC continued
financing for US$ 23.8 billion while in FY24 ECB disbursements jumped to US$
38.4 billion.
Although
External Commercial Borrowings (ECBs) have their advantage such as lower rates
of interest they also have their disadvantages. The equity of a company may
decline because of a careless borrowing culture; there will be increased debt
levels which are reflected in the financial ratios. Firms may face a downgrade
of their ratings meaning that they are risky hence a low market value. This
means that when companies borrow in foreign currencies, they stand to cut their
costs through hedging by experiencing exchange rate risks. There are also
borrowing constraints and standard durations; long maturities are
characteristic of large borrowings. These are some of the risks that companies
need to be careful of when conducting ECBs.
CONCLUSION
In
conclusion, External Commercial Borrowings (ECBs) have added an important
source of financing options to assist the development of India’s economy. ECBs
have thus facilitated access to global capital and bolstered domestic savings
investments, especially in infrastructure, manufacturing, and Energy. While
using ECBs, some benefits which include lower interest costs and sourcing of
funds in foreign currency are obvious, the negatives which include exchange
risk and ballooning of external liabilities are also not far from observation.
To guard against these risks India has put in place the legal framework in the
provision of ECBs under FEMA. Here, the Reserve Bank of India (RBI) stands as
the central supervisory authority and monitors ECB inflows to ensure that they
are properly utilized for productive purposes and Total Macro Economic Impact
Analysis of the Indian Economy and Consistent with the macroeconomic objectives
of Reserve Bank of India. It is therefore clear that as India becomes more and
more integrated into the international economy the appropriate use of ECBs will
be necessary. This means that, while foreign capital will need to be tapped for
its advantage, measures that can neutralize the risks will be required to ensure
continued sustainable economic growth and a sound financial system.
