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EXTERNAL COMMERCIAL BORROWINGS & BUYERS CREDITOPTIONS FOR LONG TERM & SHORT TERM BORROWING REQUIREMENT FOR

MNCS

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ABSTRACT

In this project, titled External commercial borrowings & buyers creditoptions for long term & short term borrowing requirement for MNCs The aim is to analyze whether ECB for long term and BC for short term borrowing for the MNCs, is best option, with detailed look on procedure for application, guidelines, compliances, Indian government policy, rules and regulations placed at present.

This project study will enable finance manager to understand the options viz, ECB and BC, and make use of the same if its feet in for his organization and save borrowing /interest cost.

The study explains ways in which both these options can be of assistance in long-rang planning, budgeting and borrowing cost management to strengthen financial performance and help avoid financial difficulties.

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INTRODUCTION An external commercial borrowing (ECB) is an instrument used in India to facilitate the access to foreign money by Indian corporations and PSUs (public sector undertakings). ECBs include commercial bank loans, buyers' credit, suppliers' credit, securitised instruments such as floating rate notes and fixed rate bonds etc., credit from official export credit agencies and commercial borrowings from the private sector window of multilateral financial Institutions such as International Finance Corporation (Washington), ADB, AFIC, CDC, etc. ECBs cannot be used for investment in stock market or speculation in real estate. The DEA (Department of Economic Affairs), Ministry of Finance, Government of India along with Reserve Bank of India, monitors and regulates ECB guidelines and policies.

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Detailed look on procedure for application, guidelines, compliances, Indian government policy, rules and regulations placed at present

External Commercial Borrowings (ECB) refer to commercial loans in the form of bank loans, buyers credit, suppliers credit, securitized instruments (e.g. floating rate notes and fixed rate bonds, non-convertible, optionally convertible or partially convertible preference shares) availed of from non-resident lenders with a minimum average maturity of 3 years. ECB can be accessed under two routes, viz., (i) Automatic Route, i.e. do not require Reserve Bank / Government of India approval. and (ii) Approval Route, in case of doubt as regards eligibility to access the Automatic Route, applicants may take recourse to the Approval Route. Master Circular on External Commercial Borrowing released by Reserve bank of India on yearly basis in July month every year on website Hyperlink : to access RBI Portal Master Circular http://www.rbi.org.in/scripts/BS_ViewMasterCirculardetails.aspx

RBI Master Circular on ECB and trade Credits.pdf

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To avail ECB one must go through above Master circular and understand following concepts defined therein for automatic and approval route. 1. Eligible Borrowers 2. Recognized Lenders 3. Amount and Maturity 4. All-in-cost ceilings 5. End-use 6. End-uses not permitted 7. Guarantees 8. Security 9. Parking of ECB proceeds 10. Prepayment 11. Refinancing of an existing ECB 12. Debt Servicing 13. Procedure 14. Refinancing/rescheduling of an existing ECB After understanding above concepts, eligible borrowers can enter into agreement with recognized lenders adhering to maturity and all in cost ceiling. Eligible Borrower need to file Application in Form 83 to Reserve bank of India through Authorized Dealers. Hyperlink : to see list of Authorized Dealers http://www.rbi.org.in/commonman/English/scripts/authorizeddealers.aspx

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Form 83 in brief: Form 83 is an application form to be submitted to Reserve Bank of India reporting of loan agreement details within 7 days of signing of such agreement, for allotment of LRN (Loan Registration Number). This Application form containing details of lender and borrower, foreign currency of loan, interest rate i.e LIBOR (London Interbank Offer rate) Plus basis Points. At present all in cost ceilings is as given below Average Maturity Period All-in-cost Ceilings over 6 month LIBOR* Three years and up to five years More than five years 350 basis points 500 basis points

* for the respective currency of borrowing or applicable benchmark Interest payment schedule, principal repayment schedule, drawdown schedule are also to be mentioned in this application form. Besides this any change in above should be reported by filing revised form 83 through AD within 7 days of such change. After due verification Reserve bank of India allot LRN no. Borrower has to use this LRN no for all future correspondence, for change, addition, reduction of loan. Format of Form 83

DRAFT FORM 83.docx

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Average Maturity Period : Borrower has to comply with average maturity period of minimum 3 years for any change in drawdown, reduction in loan, this can be verified through calculation as per given below illustration.
Loan Amount USD 3400000

No. of Days ** balance Date of drawal / Repayment (MM/DD/YYYY) Column 1 28/09/12 28/10/12 28/11/12 28/12/12 28/01/13 28/03/13 27/09/17 Drawal Column 2 1694500 965100 191200 291300 38200.00 219700.00 3400000.00 Repayment Column 3 Balance Column 4 1694500.00 2659600.00 2850800.00 3142100.00 3180300.00 3400000.00 0.00 with the borrower Column 5 30 30 30 30 60 1619

Product = ( Col 4 * Col 5) / (loan amount * 360 ) Column 6 0.0415 0.0652 0.0699 0.0770 0.1559 4.4972 0.0000

Average Maturity ** Calculated by = DAYS360(firstdate,seconddate,360)

4.9067

Borrower needs to submit monthly return to reserve bank of India through AD in form ECB2, on monthly basis, within 7 working days of end of every month, reporting all transactions during the month. Why ECB Loan preferred by MNCs over local loan types.

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At present PLR (prime lending rate) or Base Rate is more than 8% in India, All banks are lending to corporate and business institutions over and above this PLR /BR depending on rating or assessment of that corporate and business institutions, even for A+ rated corporate and business institutions interest rates are more than 8-9% per annum for long term borrowing, more so in India Inflation rate is higher, ECB loan from Foreign institutions, Private lenders allows these Indian Counterparts of corporate and business institutions to borrow funds at 6 months LIBOR + Max 350 basis Points, which comes less than 6% as per present rate. Therefore ECB loan is preferred over local borrowing or debt loans. Given below is chart showing 6 months USD LIBOR rate on quarterly basis since 2005.
Date 29/12/2004 29/03/2005 28/06/2005 28/09/2005 28/12/2005 29/03/2006 28/06/2006 27/09/2006 27/12/2006 28/03/2007 27/06/2007 29/09/2007 27/12/2007 27/03/2008 26/06/2008 26/09/2008 USD 6 Months LIBOR Rate Date 2.7750 26/12/2008 3.3800 28/06/2009 3.6600 28/09/2009 4.2000 29/12/2009 4.6900 29/03/2010 5.1100 28/06/2010 5.6175 28/09/2010 5.3719 29/12/2010 5.3606 29/03/2011 5.3238 28/06/2011 5.3750 28/09/2011 5.1325 29/12/2011 4.7175 29/03/2012 2.6325 28/06/2012 3.1338 28/09/2012 3.8763 29/12/2012 USD 6 Months LIBOR Rate 1.8113 1.0950 0.6388 0.4340 0.4425 0.7472 0.4625 0.4569 0.4605 0.4008 0.5484 0.8085 0.7343 0.7344 0.6359 0.5083

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Six Month Libor History ( 6 Month Libor) Jan Feb Mar Apr May 2012 0.809 0.778 2011 0.456 0.454 2010 0.430 0.384 2009 1.750 1.660 2008 4.596 3.041 2007 5.401 5.372 2006 4.813 4.991 2004 1.211 1.203 2003 1.353 1.336 2002 1.989 2.068 2001 5.361 4.955 2000 6.238 6.328 1999 5.036 5.168 0.749 0.733 0.748 464

Jun

Jul

Aug

Sep

Oct

Nov

Dec

0.460 0.431 0.403 0.398 0.430 0.486 0.558 0.619 0.748

0.387 0.444 0.531 0.752 0.753 0.668 0.497 0.463 0.448 0.461 1.803 1.736 1.565 1.240 1.111 0.925 0.755 0.629 0.564 0.488 2.931 2.614 2.965 2.911 3.109 3.084 3.118 3.981 3.121 2.591 5.321 5.358 5.384 5.381 5.386 5.327 5.535 5.133 4.806 4.910 5.120 5.288 5.322 5.639 5.547 5.450 5.370 5.390 5.350 5.365 1.160 1.368 1.579 1.942 1.986 1.991 2.170 2.301 2.624 2.775 1.262 1.290 1.223 1.124 1.151 1.210 1.180 1.221 1.230 1.219 2.332 2.100 2.090 1.948 1.863 1.815 1.751 1.618 1.471 1.383 4.711 4.231 3.990 3.827 3.694 3.479 2.532 2.173 2.101 1.983 6.530 6.614 7.064 7.014 6.887 6.831 6.761 6.721 6.678 6.208 5.083 5.075 5.193 5.633 5.680 5.913 5.974 6.144 6.063 6.136

2005 2.958 3.1495 3.388 3.415 3.531 3.691 3.924 4.082 4.215 4.447 4.580 4.690

(Source: http://www.erate.com/six_month_libor_index.6-months-libor.htm) Upon going through above rate table it is confirmed that ECB loan interest is lower, and therefore it is viable to go for these loans wherever possible. However borrower should comply with all requirements and also follow all rules and regulations of FEMA, and adhere to RBI guidelines to avoid compounding proceedings.

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BUYERS CREDIT INTRODUCTION Buyers Credit refers to loans for payment of imports into India arranged on behalf of the importer through an overseas bank. The offshore branch credits the nostro of the bank in India and the Indian bank uses the funds and makes the payment to the exporter bank as an import bill payment on due date. The importer reflects the buyers credit as a loan on the balance sheet.

Benefits of Buyers Credit: The benefits of buyers credit for the importer is as follows: The exporter gets paid on due date; whereas importer gets extended date for making an import payment as per the cash flows. The importer can deal with exporter on sight basis, negotiate a better discount and use the buyers credit route to avail financing. The funding currency can be in any FCY (USD, GBP, EURO, JPY etc.) depending on the choice of the customer. The importer can use this financing for any form of trade viz. open account, collections, or LCs. The currency of imports can be different from the funding currency, which enables importers to take a favourable view of a particular currency.

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Buyers Credit Process flow: 1. Indian customer imports the goods either under DC / LC, DA / DP or Direct Documents. 2. Indian customer requests the Buyers Credit Consultant before the due date of the bill to avail buyers credit finance. 3. Consultant approaches overseas bank for indicative pricing, which is further quoted to Importer. 4. If pricing is acceptable to importer, overseas bank issues offer letter in the name of the Importer. 5. Importer approaches his existing bank to get letter of undertaking / comfort (LOU / LOC) issued in favour of overseas bank via swift. 6. On receipt of LOU / LOC, Overseas Bank funds existing banks Nostro account for the required amount 7. Existing bank to make import bill payment by utilizing the amount credited (if the borrowing currency is different from the currency of Imports then a cross currency contract is utilized to effect the import payment) 8. On due date existing bank to recover the principal and Interest amount from the importer and remit the same to Overseas Bank on due date. Cost Involved: The cost involved in buyers credit is as follows:

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Interest cost: This is charged by overseas bank as a financing cost. Normally it is quoted as say 3M L + 350 bps, where 3M is 3 Month, L is LIBOR, & bps is Basis Points (A unit that is equal to 1/100th of 1%). To put is simply: 3M L + 3.50%. One should also check on what tenure LIBOR is used, as depending on tenure LIBOR will change. For example as on day, 3 month LIBOR is 0.33561% and 6 Month LIBOR is 0.50161% Letter of Comfort / Undertaking: Your existing bank would charge this cost for issuing letter of comfort / Undertaking Forward / Hedging Cost Arrangement fee: Charged by Buyers Credit Agents / Brokers how is arranging buyers credit for you. Other charges: A2 payment on maturity, For 15CA and 15CB on maturity, Intermediary bank charges etc. Withholding Tax(WHT): The customer has to pay WHT on the interest amount remitted overseas to the Indian tax authorities. <The WHT is not applicable where Indian banks arrange for buyers credit through their offshore offices> Regulatory Framework: RBI has issued directions under Sec 10(4) and Sec 11(1) of the Foreign Exchange Management Act, 1999, stating that authorised dealers may approve proposals received (in Form ECB) for short-term credit for financing by way of either suppliers credit or buyers credit of import of goods into India, based on uniform criteria.

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Over the years there has been changes in norms. Current norm as per RBI Master Circular on External Commercial Borrowing (ECB) and Trade Finance 2011 are A. Amount and Maturity Maximum Amount Per transaction : $20 Million Maximum Maturity in case of import of non capital goods: upto 1 year from the date of shipment

Maximum Maturity in case of import of capital goods : upto 3 years from the date of shipment B. All-in-cost Ceilings Upto 1 year : 6 Month Libor + 350 bps * Upto 3 years : 6 Month Libor + 350 bps * All applications for short-term credit exceeding $20 million for any import transaction are to be forwarded to the Chief General Manager, Exchange Control Department, Reserve Bank of India, Central Office, External commercial Borrowing (ECB) Division, Mumbai.

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CASE STUDY- AN MNC- Manufacturing of Calcium Carbonate The name of Company is not been mentioned due to Company Policy of not using name any ware without board of directors permission. Therefore for this project purpose the name used as ABC Company ABC company is MNC closed privately held Switzerland based Company, this company has decided to enter into India with manufacturing plant after seeing overall growth for their products in India, company had planning of expanding its activities, therefore studied various options for long term funding. The borrowing in India through commercial banks was costing around 12-13% p.a. Company has then informed by local Finance team about other option of ECB-Commercial loan through which Private lender can finance Indian company upon satisfying following conditions as given below. 1] Recognized lender Borrowers can raise ECB from internationally recognized sources, such as (a) international banks, (b) international capital markets, (c) multilateral financial institutions (such as IFC, ADB, CDC, etc.) / regional financial institutions and Government owned development financial institutions, (d) export credit agencies, (e) suppliers of equipments, (f) foreign collaborators and (g) foreign equity holders [other than erstwhile Overseas Corporate Bo d i e s ( O C B s ) ] . Companies registered under Section 25 of the

Companies Act,1956 and are engaged in micro finance will be permitted to avail of ECBs from international

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banks, multilateral financial institutions, export credit agencies, foreign equity holders, overseas organizations and individuals. A "foreign equity holder" to be eligible as recognized lender under the automatic route would require minimum holdin g of paid-up equ it y in the borro wer compan y a s se t out belo w: (i) For ECB up to USD 5 million - minimum paid-up equity of 25 per cent held directly by the lender, (ii) For ECB more than USD 5 million - minimum paid-up equity of 25 per cent held directly by the lender and ECB liability-equity ratio not exceeding 4:1 Besides the paid-up capital, free reserves (including the share premium received in foreign currency) as per the latest audited balance sheet shall be reckoned for the purpose of calculating the equity of the foreign equity holder in the term ECB liability-equity ratio. Where there are more than one foreign equity holder in the borrowing company, the portion of the share premium in foreign currency brought in by the lender(s) concerned shall only be considered for calculating the ECB liability-equity ratio for reckoning quantum of permi s s i b l e E C B . For calculating the ECB liability, not only the proposed borrowing but also the outstanding ECB from the same foreign equity holder lender shall be reckoned. Overseas organizations and individuals providing ECB need to comply with the following safeguards: (i) Overseas Organizations proposing to lend ECB would have to furnish to the AD bank of the borrower a certificate of due diligence from an overseas bank, which, in turn, is subject to regulation of host-country regulator and adheres to the Financial Action Task Force (FATF) guidelines. The certificate of due

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7 diligence should comprise the following (i) that the lender maintains an account with the bank for at least a period of two years, (ii) that the lending entity is organised as per the local laws and held in good esteem by the business/local community and (iii) that there is no criminal action pending against it. Since the company is 100% foreign share holding company, ECB liability-equity ratio not exceeding 4:1, company could enter into agreement with overseas foreign collaborator. This would enable overseas MNC company finance the its Indian counterpart ABC Company at much lower rate, and thereby lowest cost of borrowing, which will make ABC company more competent due to lower cost. ABC Company since then started 2 more projects by using ECB loan financing and able to establish itself in a very completive Indian business environment. However due all its raw material sources are from outside india, also the business, was more of volume nature, it started facing working capital crunch, again the finance team found solution in buyers credit facility. Company has started using Buyers credit facility instead of Overdraft/Cash credit facility. The comparison of savings after using buyers credit facility are shown given below. Rate at which Overdraft facility available to the company 12% Import Shipment USD 1000000 Average time of Business Cycle 90-105 days Interest expenses if Interest expenses if used used through OD/CC through OD/CC 12% USD3MLIBOR+275BPS+W/h Tax+TelexChgs+Certification Chgs

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Effective rate

12%

3.12%

+USD

25

Telex

Chgs+INR 2000 Total In Rs if Fx rate @54 for 90 days Therefore Saving of more than Rs.10 lakhs for this transaction 15,97,808 4,18,780

Average time of Business Cycle : This is time taken by company from sourcing of raw material, converting into finished goods, sales, collection. Caution: However as this transaction involves foreign currency there is always risk for exchange fluctuation, and to cover these risk, forward contract or with or without option can be entered into.

FINDINGS FROM CASE STUDY

From the above case study, we can see that ECB is one of the best source for MNCs and other Business institutions for availing finance at lowest interest rate in india, and enjoying the Interest parity benefit. Also by using Buyers Credit one can solve the problem of high cost of working capital. Though there is always risk of exchange fluctuation in long run due to open market, demand and supply factors play important role.

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SUGGESTIONS, RECOMMENDATIONS AND CONCLUSION 1. The liquidity position of the company by using buyers credit can be utilized in a better or other effective purpose. 2. The company can be use the extended credit facilities by using Buyers credit by rolling over 90 days credit to further period till 365 days, thereby can save itself in extreme adverse situations. 3. In India due to high rate of inflation, local borrowing cost always be on higher side than from foreign borrowing through ECB. 4. Efforts should be taken to increase the overall efficiency in return out of working capital employed by making used of the available resource effectively. 5. The company can increase its sources of funds to make effective research and development system for more profits in the years to come. LIMITATIONS AND SCOPE FOR FURTHER STUDY As the study is based on secondary data, the inherent limitation of the secondary data would have affected the study. The rates taken in examples are likely to be a changes as per market demand & supply, and so might not give a proper indication in future market environment. This study need to be interpreted carefully. They can provide clues to the companys performance or financial situation. But on their own, they cannot show whether performance is good or bad. It requires some quantitative information for an informed analysis to be made.

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BIBLOGRAPHY

Websites: http://en.wikipedia.org/wiki/External_Commercial_Borrowing http://www.rbi.org.in/ http://www.homefinance.nl/english/international-interest-rates/libor/usdollar/liborrates-6-months-usd.asp http://www.erate.com/six_month_libor_index.6-months-libor.htm http://www.bbalibor.com/

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