External Commercial Borrowing

External Commercial Borrowing (ECB) in India refers to the process of borrowing funds from foreign sources by Indian companies or Public Sector Units (PSU), such as loans, bonds, or other financial instruments. It is an essential financial instrument for businesses seeking to expand their operations and fund new projects by accessing foreign capital. In this article, you will learn definition, characteristics, advantages, disadvantages, etc.

This article will provide key insights for GS Paper-III Economy of UPSC IAS Exam.

Table of Content

• What is External Commercial Borrowing?            
• Characteristics of ECB    
• How can ECB be availed?            
• Eligible Borrowers and Recognized Lenders         
• Advantages of using ECB
• Disadvantages of using ECB
• External commercial borrowing as per the Economic Survey 2023             
• Committees on External commercial borrowing
• Conclusion        
• Frequently Asked Questions       

What is External Commercial Borrowing?

• External Commercial Borrowing (ECB) in India refers to the process of borrowing funds from foreign sources by Indian companies or Public Sector Units (PSU), such as loans, bonds, or other financial instruments.
• These funds can be utilized for purposes, such as expanding the business, acquiring assets, or repaying existing debts.

Characteristics of ECB:

• The sources of ECB can be diverse, including foreign banks, international financial institutions, and foreign subsidiaries of Indian companies.
• The borrowing can be in-
  • Loan denominated in rupee but repaid in Indian rupees
  • Foreign currency-denominated loans but repaid in a foreign currency
• The Reserve Bank of India (RBI) oversees the regulatory aspects of ECB by imposing limits on the amount of ECB that Indian companies can access and the specific purposes for which it can be utilized.
• To access ECB, companies must meet certain eligibility criteria, such as having minimum credit ratings and maintaining specific debt-equity ratios.
• Utilizing ECB provides advantages such as access to a wider pool of capital, diversification of funding sources, and potentially lower borrowing costs.
• However, ECB also possesses some risks that companies should consider before opting such as exchange rate fluctuations, sovereign risk, creditrisk, and regulatory risks.
  • These factors can impact a company’s financial position and an economy in a larger terms.

How can ECB be availed?

• There are two methods to secure funds through ECBs: the approval route and the automatic route.
• The government has established eligibility regulations for availing finance under the automatic route, but are subjected to an upper limit, maturity period and the purpose of funds.
• Meeting these criteria allows companies to raise funds without requiring prior approval.
• The RBI has provided circulars and formal guidelines on the borrowing structure.
• The approval route applies to certain pre-specified sectors, where companies must obtain explicit permission from the RBI or the government before utilizing External Commercial Borrowing.
• To maintain a clean inflow, the RBI has categorized “eligible entities” among the borrowers and “recognized non-residents” among potential lenders.
• The RBI implements checks through forms of ECB, end-use restrictions, and minimum maturity periods.

Eligible Borrowers and Recognized Lenders:

• There are two types of ECBs available: Foreign Currency ECB (FCY ECB) and Indian Currency ECB (INR ECB).
• Eligible borrowers include entities that are qualified for Foreign Direct Investment (FDI) and specific institutions like Port Trusts, Units in Special Economic Zones, Small Industries Development Bank of India, and the EXIM Bank of India.
• To secure ECBs, borrowers must approach ‘recognized lenders,’ which include entities belonging to the International Organization of Securities Commissions (IOSCO) and Financial Action Task Force (FATF).
• Recognized lenders also includes multilateral and regional financial institutions, foreign subsidiaries of Indian banks (adhering to prudential norms), and foreign equity holders (individuals) as per the ECB Master Direction of RBI.

Advantages of using ECB:

• ECB offers Indian companies the advantage of accessing more capital from foreign sources, proving beneficial for those with limited domestic funding options.
• It allows companies to diversify their funding sources by reducing their reliance on domestic financing and enhancing their financial stability.
• Compared to domestic borrowing, ECB can be a more cost-effective option, as foreign lenders may provide lower interest rates due to lower risks and other factors associated with it.
• ECB offers longer repayment periods which provides companies more time to repay their loans.
• ECB provides opportunity to Indian companies to gain access to advanced technology and expertise from foreign sources, thus enhancing their competitiveness and productivity.
• It enables companies to venture into global markets by expanding their operations internationally and switching to new growth opportunities.

Disadvantages of using ECB:

• ECB is linked with the destabilisation of exchange rate of Indian Rupee, as fluctuations in the Indian rupee against foreign currencies can impact loan repayment costs.
  • If the rupee’s value declines against the foreign currency in which the loan is denominated, companies may face higher financing expenses.
  • This could even lead the company to engage in cost-hedging.
    • Hedge is an investment to counter or minimize the risk of adverse price movements in an asset or security.
• Credit risk is also present as foreign lenders may not have the same protection level as domesticlenders in case of default.
  • Thus, companies may face greater risks if they fail to repay their loans.
  • This, may erode the reputation of other Indian companies which may further discourage foreign investors to invest in Indian companies.
• The company may develop a lax attitude, as the funds becomes available at lower rates easily.
  • This can make companies borrow abundantly and could lead to higher debt on the balancesheet of the company, thereby affecting its financial ratios.
    • This may lower the credit rating of their equity.
• ECB is subject to regulatory risk, wherein changes in government regulations or policies related to ECB may affect borrowing availability and cost.
• Relying on foreign funding through ECB may make Indian companies dependent on external capital, posing risks if access to foreign funding diminishes or becomes costlier in the future.
• Reputation risk is another aspect as defaulting on ECB obligations could harm a company’s reputation and impede its ability to secure financing in the future.
  • This will lead to fall in value of equity of the company in market over a period of time.

External commercial borrowing as per the Economic Survey 2023:

• ECBs to India has recorded net outflows of US$ 3.0 billion in first quarter of fiscal year 2023 against net inflows of US$ 5.0 billion in 2022.
  • This was caused due to more repayments in comparison to fresh disbursals.
• Rising yields on corporate bonds and higher interest or hedging costs on ECBs have made credits from banks more attractive than the previous years.

Committees on External commercial borrowing:

• The finance ministry has set up the committee in 2013 to develop a framework of access to domestic and overseas capital markets. 
• The committee was headedby M.S. Sahoo.
• The committee has also made recommendations on the issue of foreign currency convertible bonds and depository receipts.

Recommendations of the committee:

• The committee has proposed liberalization of ECB rules.
• ECB rules must allow all Indian companies to borrow in foreign currency without any upper limit, while adhering to specific hedging requirements.
• Eliminate constraints related to lenders such as loan maturity, borrowing costs, and end-use restrictions.
• Remove the obligatory prior approval from the RBI for such borrowings.
• The aim of the ECB framework shall be to allow Indian firms option to borrow in foreign currency provided that sufficient safeguards are there to avoid any risk that may arise from many firms having exposure to unhedged foreign currency.

Conclusion

External Commercial Borrowing (ECB) serves as a crucial financial tool for India, enabling corporations to access funding beyond the domestic market. This avenue of borrowing is particularly beneficial for large-scale infrastructure and industrial projects that require substantial investment, which might not be fully available within the country. ECBs offer the advantage of lower interest rates compared to domestic borrowing, thus providing a cost-effective way for companies to fund their expansion and growth.

However, while ECBs contribute to the influx of foreign capital, they also expose the borrowers to currency exchange risks, which can lead to increased financial liability in the case of currency depreciation.

Ref: Source-1

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