By Tarunkumar G. Singhal
Raman Jokhakar
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The Reserve Bank of India – after consultation with the central government – released an updated set of guidelines applicable to Indian corporate groups’ external commercial borrowing (ECB). The change is a significant liberalisation, in that it considerably lessens the number of restrictions placed on the end-use of funds that companies have borrowed from abroad. The focus of the RBI, according to its statement, was on long-term borrowing, which it said would make “repayments more sustainable and minimise roll-over risks for the borrower.” The list of permissible lenders has also been expanded. It now includes pools of long-term capital such as pension funds, insurance companies and even sovereign wealth funds. Simultaneously with expanding the scope of ECBs, the RBI also acted to effectively narrow the number of Indian companies, which would successively raise ECBs in foreign currency, by cutting the allowable ceiling for borrowing rates above the London Inter-Bank Offered Rate or LIBOR. For foreign currency borrowing with maturity of between three and five years, the permissible rate was cut by 50 basis points (bps) to 300 bps above LIBOR. The permissible spread for longer-term borrowing is correspondingly higher.
The dangers of an ECB debt binge are well known. Indian companies are faced with high interest rates at home, and dollar-denominated foreign rates can look attractive. In the past, corporate groups have funded over-expansion and acquisition sprees through such debt, only to be left stranded when the situation turned adverse. Few Indian companies hedge carefully enough – and, indeed, the market for hedging currency risk beyond a few months may not be deep and liquid enough to be attractive. Nor is such hedging cheap. The RBI clearly thinks that this is more of a problem for short-term debt, in which temporary volatility of the currency can cause crises when large tranches of debt become difficult to roll over or repay. It is, thus, incentivising longer-term debt that could be used by, say, real estate investment trusts to help bail out India’s 38 struggling realty sector. While this logic is certainly sound as far as it goes, there remains the larger question of the future direction of the rupee. If it is significantly overvalued at the moment but nevertheless apparently stable, some companies could take on long-term debt that will grow on their balance sheets when the rupee depreciates to closer to its real value.
The option, of course, is to seek out rupee-denominated debt abroad. Certainly, the government has made significant progress in promoting rupee-denominated “masala bonds”. And as this newspaper has reported, some markets have seen excellent growth in retail bonds with the rupee as the base currency. These have largely been issued so far by offshore institutional lenders, but earlier this year the RBI allowed Indian companies to borrow abroad in rupees too. The guidelines released on Monday put rupee-denominated borrowing on a par with dollar-denominated ECB – and, in fact, made special allowances for non-bank financial corporations and microfinance institutions to raise rupees from abroad. It is to be hoped that Indian companies will recognise that currency risk is best borne by large global financiers and will not be overly tempted by low interest rates and the associated currency risk.
