External Commercial Borrowing – Part I

1. Introduction

External Commercial Borrowings (ECBs) play a significant role in any developing

economy since its domestic funds are usually unable to meet growing demand, more
so when the cost of domestic borrowing is higher than that of international funding.
Raising ECBs by Indian residents directly adds to India’s external debt and foreign
exchange exposure and therefore, the same is highly regulated by the RBI. Mismatch
of tenure and usage of ECBs can be disastrous for the economy as was evident from
the South East Currency Crisis. Therefore, many restrictions are placed by RBI to
ensure that short-term borrowings are not used for long-term use and vice versa.
Policy guidelines pertaining to ECBs have been revised from time to time. Recently,
on August 1, 2005 new guidelines for ECBs have been announced. In this part, we
shall discuss the provisions related to raising of External Commercial Borrowings
under the automatic route of Reserve Bank of India.

External Commercial Borrowings (ECBs) are a key component of India’s overall

external debt which includes, inter alia, external assistance, buyer’s credit, supplier’s
credit, NRI deposits, short-term credit and Rupee debt. ECB guidelines, need to be
assessed in the backdrop of various external debt sustainability indicators relevant to
emerging economic needs.

2. Meaning

External Commercial Borrowings (ECBs) are defined to 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 borrowing from the private sector window of Multilateral Financial
Institutions such as International Finance Corporation (Washington), ADB, IFC, CDC
etc.

Even loans from Foreign Equity Holders are considered as ECBs.

Thus ECBs mean foreign currency loan raised by residents from recognised lenders.

Financial leases and Foreign Currency Convertible Bonds are also covered by ECB
guidelines.

3. ECB Guidelines — Historical prospective

ECBs, were governed by the Ministry of Finance. Government had issued

consolidated guidelines on policies and procedures for ECBs in July, 1999. The said
guidelines were amended from time to time. The Central Government had last
revised these guidelines on 19th January, 2004. However, subsequently RBI had
issued comprehensive Circular No. 60 dated 31st January, 2004, contents of which
later on were incorporated by way of amendments to the original Notification No.
3/2002-RB vide Notification No. 126/2004-RB, dated 13th December, 2004.

From 1st February, 2004 major restrictions were imposed on raising ECBs, by Indian
borrowers, such as ban on end use of ECB for working capital, general corporate
purpose, cap of US$ 500 million per financial year under the Automatic Route etc.
Submission of ECB-2 return to RBI on a monthly basis duly certified by the
designated Authorised Dealer as well as a Chartered Accountant was made
mandatory with effect from 1st February, 2004. On April, 2005, RBI permitted NGOs
engaged in micro-finance activities to raise ECB under automatic route vide its
Circular No. 40. The revised guidelines issued by the Government of India on 19th
January, 2004 and the original comprehensive guidelines of 1999-2000 have
practically become redundant in the light of these developments.

RBI has further amended its earlier ECB guidelines vide Circular No. 5, dated August
1, 2005. Notification making amendments based on these guidelines is still awaited.

ECB guidelines can be divided in three broad periods. Prior to 1st February, 2004,
when there were less restrictions on raising ECB and the same was allowed for
general corporate purpose including working capital requirements of companies.
From 1st February, 2004 to 31st July, 2005, ECBs were governed by RBI guidelines
covered by the A.P. (DIR Series) Circular No. 60, dated 31st January, 2004, which
prohibited raising of ECB for general corporate purposes/working capital and imposed
several other restrictions and reporting requirements. New ECB guidelines are
announced by RBI effective from August 1, 2005 which imposes further restrictions
in terms of percentage of shareholding by the leaders, permissible debt equity ratio
and so on.

Provisions of ECB discussed in this Article are based on the latest RBI guidelines on
ECB covered by Circular No. 5, dated 1st August, 2005.

4. Different schemes of ECB

There are three broad schemes — or more appropriately, following facilities under
ECB schemes:

i. Trade Credit
ii. Automatic Route
iii. Approval Route

In this part, we will cover the first two schemes; i.e., Trade Credit and Automatic
route only.

4.1 Trade credit for imports into India

Trade Credits’ (TC) refer to credits extended for imports directly by the overseas
supplier, bank and financial institution for original maturity of less than three years.
Depending on the source of finance, such trade credits include suppliers’ credit or
buyers’ credit. Suppliers’ credit relates to credit for imports in to India extended by
the overseas supplier, while buyers’ credit refers to loans for payment of imports in
to India arranged by the importer from a bank or financial institution outside India
for maturity of less than three years. It may be noted that buyers’ credit and
suppliers’ credit for three years and above come under the category of External
Commercial Borrowings (ECB) which are governed by ECB guidelines.

4.1.1 Amount and maturity

ADs are permitted to approve trade credits for imports into India up to US$ 20
million per import transaction for import of all items (permissible under the Exim
Policy) with a maturity period (from the date of shipment) up to one year. For import
of capital goods, ADs may approve trade credits up to US$ 20 million per import
transaction with a maturity period of more than one year and less than three years.
No roll-over/extension will be permitted by the AD beyond the permissible period.

As hitherto, ADs shall not approve trade credit exceeding US$ 20 million per import
transaction.

4.1.2 All-in-cost Ceilings

The all-in-cost ceilings are as under:

Maturity period All-in-cost ceilings

over 6 months LIBOR*

Up to one year 50 basis points

More than one year 125 basis points

but less than three
years

* for the respective currency of credit or applicable benchmark.

The all-in-cost ceilings include arranger fee, upfront fee, management fee,
handling/processing charges, out of pocket and legal expenses, if any. The all-in-cost
ceilings will be reviewed from time to time.

4.1.3 Guarantee

ADs are permitted to issue guarantee/Letter of Undertaking (LoU)/Letter of Comfort

(LoC) in favour of overseas supplier, bank and financial institution, up to US$ 20
million per transaction for a period up to one year for import of all non-capital goods
permissible under Foreign Trade Policy (except gold) and up to three years for import
of capital goods, subject to prudential guidelines issued by Reserve Bank from time
to time. The period of such guarantees/LoU/LoC has to be
co-terminus with the period of credit, reckoned from the date of shipment.

4.1.4 Reporting arrangements

ADs are required to furnish details of approvals, drawal, utilisation, and repayment of
trade credit granted by all its branches, in a consolidated statement, on a monthly
basis.

ADs are also required to furnish data on issuance of guarantees/LoU/LoC by all its
branches, in a consolidated statement on quarterly basis.

4.2 Automatic Route for External Commercial Borrowings up to US $ 500 million or

its equivalent during a financial year
4.2.1 Permissible entities

Indian companies registered under the Companies Act, 1956 are permitted to raise
ECBs up to US $ 500 million from reputed lenders in any one financial year (April to
March). Financial intermediaries like banks, financial institutions, housing finance
companies, NBFCs, Trusts, Non-Profit making Organisations (NPOs),
Proprietorship/Partnership Concerns and Individuals are not eligible to raise ECBs
under automatic route.

Non-Government Organisations (NGOs) engaged in micro finance activities are

eligible to avail ECB.

4.2.2 Recognised lenders

a. The eligible entities can borrow in foreign currency by way of

issue of bonds, floating rate notes or other debt instruments
from following lenders:

i. International bank or international capital market, or

ii. Multilateral financial institutions, namely, IFC, ADB, CDC

etc., or

iii. Export Credit Agencies,

iv. Foreign collaborator or foreign equity holder as specified

by RBI, or

v. Supplier of equipments provided the amount of loan

raised does not exceed the total cost of the equipment
being supplied by lender, or

vi. Any other eligible entity as may be prescribed by RBI in

consultation with Government.

b. The key operative part in the credential of the overseas lender

is that ECB should be availed from an internationally recognised
source and one of the recognised categories is "foreign equity
holder" as indicated above. It is clarified that for a "foreign
equity holder" to be eligible as "recognised lender" under the
automatic route would require minimum holding of equity in the
borrower’s company as under:

i. ECB up to US$ 5 million — minimum equity of 25 per

cent held directly by the lender.

ii. ECB more than US$ 5 million — minimum equity of 25

per cent held directly by the lender and debt-equity ratio
not exceeding 4:1 (i.e., the proposed ECB not exceeding
four times the direct foreign equity holding).

4.2.3 End use

 a. ECBs can be raised only for investment in (import of capital
goods, new projects, modernization/expansion of existing
production units) real sector — industrial sector including small
and medium enterprises (SME) and infrastructure sector in
India.

Infrastructure sector is defined as (i) power, (ii)

telecommunication, (iii) railways, (iv) roads including bridges,
(v) ports, (vi) industrial parks, and (vii) urban infrastructure
(water supply, sanitation and sewage projects).

It has been clarified by RBI that in order to determine what is

‘real sector’ one has to look whether there is a creation of real
asset or not. Through ECBs, real asset should be a created and
not merely financial asset. Thus, if one were to set up a BPO
centre, acquisition of premises can be considered as end use of
ECBs.

b. ECB can be raised for first stage acquisition of shares in the

disinvestment process and also in the mandatory second stage
offer to the public under the Government’s disinvestment
programme of PSU shares.

c. ECB can be raised for direct investment in overseas JV/WOS

subject to the existing guidelines on Indian Direct Investment in
JV/WOS abroad. (A.P. (DIR Series) Circular No. 75 dated 23rd
February 2004).

4.2.4 Restrictions on use of funds

Borrower shall not utilise the funds borrowed under any of these Schemes for

a. Investment in stock market

However, ECB can be used for first stage acquisition of shares in the
disinvestment process, and also in the mandatory second stage offer
to the public under Government’s disinvestment programme of PSU
shares.

b. Investment in real estate business

However, investment in "Integrated Townships" as defined by Ministry
of Commerce and Industry, Department of Industrial Policy and
Promotion, SIA (FC Division), Press Note 3 (2002 Series, dated 4-1-
2002) is permitted.

It should be noted that the meaning of "Integrated township

development" is different from "real estate development". Construction
by a builder of a residential building or a commercial building is also
real estate development. NRI investment is allowed in this sector. But
ECB cannot be raised for such purpose. But if there is a project of
township development (which means large projects over 100 acres of
land with equity investment of at least US $ 5 million) then ECB can be
 raised.

c. On lending
One cannot borrow to lend, except in case of investment in JV/WOS
where loans also can be given. Foreign entity cannot lend in India to
an Indian entity to enable the borrowing entity to invest abroad. ECB
can be directly used by the borrower to invest abroad.

Refinancing of ECB (i.e., raising new ECB at lower interest rate and
repaying old ECB at higher interest rate) is permitted. However,
outstanding maturity of the old loan should be maintained.

d. General corporate purpose

ECB cannot be raised for general corporate purposes.

e. Repayment of existing rupee loans

ECBs cannot be raised for repayment of existing rupee loans.

4.2.5 Amount and maturity

Reserve Bank of India has prescribed limits for minimum average maturity for ECB
loans raised under the automatic route which are as under:

Amount of maturity ECB Minimum

Average

(i) Up to US$ 20 million or its equivalent Not less than three

Years
(ii) Above US$ 20 million and upto US$ 500 Not less than five
million or its Years
equivalent

Borrowing up to US$ 20 million can have call/put option provided the minimum
average maturity of 3 years as prescribed above is complied with before exercising
put/call option.

The maximum amount of ECB which can be raised by a corporate is US$ 500 million
during a financial year.

Average maturity is defined as "weighted average of all disbursements taking each

disbursement individually and its period of retention by the borrower for the purpose
of ECBs."

4.2.6 All-in-cost ceiling

The amended Schedule I to Regulation 6(1) to the Notification No. FEMA.3/2000-RB

dated 3rd May, 2002 prescribes that "All-in-cost ceilings" for borrowing in foreign
exchange shall be specified by RBI from time to time.

The ceilings prescribed by RBI before the replacement of schedule is valid presently
in absence of any amendment thereto. The same are as follows :—
"All-in-cost" includes rate of interest, other fees and expenses in foreign currency
except commitment fee, pre-payment fee, and fees payable in Indian Rupees. All
fees paid to professionals, merchant bankers, expenses paid in foreign currency are
covered in the limit specified. Thus, it is annual cost limit rather than interest rate
limit.

Moreover, the payment of withholding tax in Indian rupees is excluded for calculating
the all-in-cost.

Minimum average All-in-cost ceilings

Maturity Period over six month
LIBOR*
Three years and up to 200 basis points
five years

More than five years 350 basis points

* for respective currency of borrowing or applicable benchmark.

Thus, if LIBOR for US $ is 1%, then the rate for ECB for average maturity exceeding
5 years cannot exceed 4.5%.

RBI has clarified that all-in-cost ceiling must be calculated over a period of loan.
Thus, in a first year the cost may increase the prescribed limit but as long as the
average cost over the period of loan remains within the ceiling there is no problem.

4.2.7 Guarantees

Banks, financial institutions and Non-Banking Finance Companies shall not provide
issue guarantee or Letter of Comfort or Standby Letter of Credit in favour of overseas
lender on behalf of their constituents for their borrowings in foreign exchange.

4.2.8 Security

The choice of security to be provided to lender/supplier is left to borrower. However,

creation of charge over immovable assets and financial securities, such as shares, in
favour of overseas lender is subject to Regulation 8 of Notification No. FEMA 21/RB-
2000 dated May 3, 2000 and Regulation 3 of Notification No. FEMA 20/RB-2000,
dated May 3, 2000, respectively. In case of immovable property, a non-resident is
not permitted to acquire immovable property except in limited circumstances.
Therefore, for offering immovable property as a security, prior approval is necessary.
Similarly for shares being offered as security, while it is possible for a non-resident to
acquire shares under automatic route, under the normal circumstances, in case of
security being enforced, the acquisition of shares cannot be under automatic route.
Therefore it may be better to obtain prior approval from RBI.

4.2.9 Parking of ECB proceeds overseas

ECB proceeds should be parked overseas until actual requirement in India. It is

clarified that ECB proceeds parked overseas can be invested in the following liquid
assets (a) deposits or Certificate of Deposit or other products offered by banks rated
not less than AA(-) by Standard and Poor/Fitch IBCA or AA3 by Moody’s;
(b) deposits with overseas branch of an authorised dealer in India; and (c) Treasury
bills and other monetary instruments of one year maturity having minimum rating as
indicated above. The funds should be invested in such a way that the investments
can be liquidated as and when funds are required by the borrower in India.

4.2.10 Prepayment

Prepayment of ECB up to US$ 200 million may be allowed by ADs without prior
approval of RBI subject to compliance with the stipulated minimum average maturity
period as applicable to the loan.

4.2.11 Refinance of existing ECB

Refinancing of existing ECB by raising fresh ECB at lower cost is permitted subject to
the condition that the outstanding maturity of the original loan is maintained.

4.2.12 Debt servicing

The designated Authorised Dealer (AD) has the general permission to make
remittances of instalments of principal, interest and other charges in conformity with
ECB guidelines issued by Government/RBI from time to time.

4.2.13 Procedure

Borrower may enter into loan agreement complying with ECB guidelines with
recognised lender for raising ECB under Automatic Route without prior approval of
RBI. The primary responsibility to ensure that ECB raised/utilised are in conformity
with the ECB guidelines and the Reserve Bank regulations/directions/circulars is that
of the concerned borrower and any contravention of the ECB guidelines will be
viewed seriously and may invite penal action. The designated AD is also required to
ensure that raising/utilisation of ECB is in compliance with ECB guidelines at the time
of certification.

4.2.14 Hedging

In cases where ECBs have been raised for meeting rupee expenditure under
Automatic Route, the Authorised Dealer has to ensure at the time of draw down that
the forex exposure of the borrower is hedged unless there is a natural hedge in the
form of uncovered foreign exchange receivables. [A.P.(DIR Series) Circular No. 23
dated 17th September, 2002]

4.2.15 Drawal of loan

The borrower can draw-down the loan only after obtaining loan registration number
from DESACS, RBI.

4.2.16 Reporting requirements

 a. In order to simplify the procedure, submission of copy of loan
agreement is dispensed with.

b. Borrowers are required to submit Form 83, in duplicate, certified by

the Company Secretary (CS) or Chartered Accountant (CA) to the
designated AD. One copy is to be forwarded by the designated AD to
the Director, Balance of Payments Statistics Division, Department of
Statistical Analysis and Computer Services (DESACS), Reserve Bank of
India, Bandra-Kurla Complex, Mumbai – 400 051 for allotment of loan
registration number.

c. Borrowers are required to submit ECB-2 Return on monthly basis

certified by the designated AD so as to reach DESACS, RBI within
seven working days from the close of month to which it relates.

d. The loan agreement entered into by the borrower with the overseas
lender shall strictly conform to these Regulations.

In the subsequent part we shall discuss provisions relating to raising ECBs under the
Approval Route of RBI.