Introduction

The Reserve Bank of India (RBI) has been closely monitoring the market situation and liquidity conditions in India over the past few months. Consequently, it has stepped in to mitigate the impact of recession risks as high ‘risk aversion’ has gripped financial markets leading to increased market volatility and sell-offs.

As a result, the RBI passed a slew of measures to liberalize norms for foreign investment and increase overseas borrowing for companies – prime among them being the changes to the External Commercial Borrowing (ECB) factor.
 

What is ECB?

• ECB refers to the debt taken by an eligible business entity in India for solely commercial purposes, with the debt being extended by external/foreign sources, i.e., recognized entities from outside India. These borrowings must conform to the rules and regulations of the RBI.
• ECBs have proven to be a crucial tool for garnering debt funds in India. It brings in foreign investment and provides access to the international market. Companies in India that seek to raise funds through ECBs must ensure that they are legally eligible for the same.

 

Why the changes?

The measures taken by the RBI have been in response to the free-falling Rupee (INR) against the U.S. Dollar (USD) and rising inflation. The INR has repeatedly crossed the INR 80/USD mark over the last month, with only minor recoveries made over short intervals, while inflation has also seen some record highs. The RBI hopes that these measures will supplement foreign exchange reserves leading to improved financial stability. This is explained in detail below:

Falling Rupee

• High level of foreign reserves are considered essential as it provides the central bank with a method to fight currency depreciation.
• As and when the currency depreciates beyond an acceptable value, the RBI, in this case, can sell USD reserves and buy the local currency to stem the fall.
• The consistent fall of the INR against the USD has pressed the RBI’s hands to intervene. In June 2021, the INR stood at 72.8/USD compared to breaching the 80/USD mark recently; a sharp and concerning fall and hence, the measures by the RBI are brought in.
• Basic components get more expensive which will shoot up prices.
• Rising prices means the RBI intervenes to help curb inflation by increasing interest rates on loans to reduce the circulation of money within the economy.

Rising Inflation

• Exchange rates are impacted when two countries trade with each other, as the weakening or strengthening of a country’s currency can influence prices.
• The weakening INR against the USD means that India has to pay a lot more for importing from USA, thereby impacting reserves.
• In response, importers will increase prices to gain some profit margins and cover costs, leading to inflation within the Indian market.
• Exports to USA become more competitive and cost-effective for them, as the USD is more valuable than the INR. Thus, the falling INR works in their favour.
• The falling INR, therefore, influences local inflation as well.

 

Key changes in the ECB framework

ECBs are always subject to restrictions on the amount that can be borrowed, the interest rate at which it is borrowed, and the purpose for borrowing. The RBI has, temporarily, increased the borrowing ceiling from USD 750 million to USD 1.5 billion to raise the influx of foreign currency. The all-in cost ceiling under ECB has also been raised by 1% (100 basis points), subject to investment grade rating. This rise in interest rates is an incentive to lenders. The all-in cost ceiling was earlier capped at 500 basis points (5%). Top-rated global companies can price bonds/loans spread within the range 100-200 basis points. Eased rules in force only till 31 December 2022.

 

Understanding the Investment Grade Rating

After the RBI released its revised policies on liberalization of forex in early July, several foreign lenders, who raise loans and bonds for Indian companies sought clarity from the RBI on whether the new rules will be applicable only to globally higher rated firms, as this would severely limit the number of beneficiaries from the scheme. Some key points are as follows:

RBI’s Clarification

• The RBI clarified that companies rated locally can make the investment grade cut for availing the benefits of the revised, time-sensitive ECB policy.
• Unambiguous statement that all-in cost ceiling will be available to eligible borrowers who make the investment grade rating from Indian Credit Rating Agencies (ICRAs).
• The purpose is to enhance the pool of beneficiaries under the scheme.

Understanding the Investment Grade Rating System

• Companies rated well domestically may not always make the investment-grade cut when rated by foreign agencies. Hence, this clarification was sought.
• An offshore rating will be significantly lower than domestic rating, as the former depends on the sovereign rating of the country as well.
• For example, a ‘AAA’ rated company, which represents highest safety and lowest risk of turning into a defaulter, by the ICRA is likely to be rated ‘Baa3’ by Moody’s – a renowned international rating agency. ‘Baa3’ is the lowest rating on Moody’s scale.
• India’s sovereign rating is ‘BBB-’ the lowest ranking on the overall international investment grade. Consequently, most Indian companies are also capped at ‘BBB-’.
• Entities rated between ‘AA’ and ‘A’ would find their ranks in the High Yield category, while the rest will struggle to find even an acceptable rating for raising funds due to overseas rating agencies.
• Therefore, international agencies view India to be a country with companies, which have a high risk and high chance of defaulting. Hence, the clarification was sought.

 

Importance of providing ECBs to locally rated companies

Following could be the potential impact of allowing ICRA rated firms the opportunity to raise funds through ECBs:

• According to the external debt report, ECB is the largest component of external debt in India. Companies had taken advantage of low interest rates following the onset of the pandemic.
• Because of exposure to a larger market, companies are able to raise large and diversified funds – much more than what is provided in the domestic market and hence ECBs are an attractive proposition.
• ECB is essentially a loan. Therefore, domestically well-rated companies will provide security to overseas lenders on ECBs. Smaller companies can feel secure, as ECBs do not lead to diluted stakes or threats of takeovers in case of default.
• This provides exposure to international markets for smaller, but creditworthy companies, who are rated well by ICRAs, but did not have the opportunity to enter the international fray until now.
• As more companies are exposed to the international market, it could lead to the discovery of secure and better financial institutions that may have been under the radar.

 

Conclusion

The Rupee is likely to continue with its inconsistencies, while inflation worldwide is recording new highs. The intervention by the RBI to shore up forex reserves are welcome, but it must not be the end all and be all.

Amidst tight global financial conditions and interest rates hikes by the US Federal Bank, more fundamental reforms are needed for long term solutions. However, for short to medium term, the RBI has done its bit and it remains to be seen how effective these relaxations are. 

In the largest external commercial borrowing by a private finance company in India, mortgage major HDFC has completed a USD 1.1 billion 'syndicated social loan facility' to fund affordable home loans in India. This is perhaps a sign of things to come for the remainder of the year.