External Commercial Borrowings Rise Amid Domestic Funding Constraints

Indian corporates are borrowing more via overseas loans and bonds as domestic banks remain cautious and funding rates in the debt markets remain elevated.

Companies have taken approvals to raise over $29 billion between January and June 2019, shows data put out by the Reserve Bank of India. This is just short of the $31 billion in approvals for external borrowings in 2018. The RBI shares data on approvals for external borrowings taken by companies. The final amount raised may differ marginally.

Of the $29 billion in approvals in 2019, $12 billion came in March. This, according to the details provided by the regulator, included $5 billion raised by ArcelorMittal India Pvt. Ltd, likely for payments due on its resolution plan for Essar Steel Ltd.

Excluding that transaction, external borrowing approvals add up to $24 billion in the first half of the year compared with $15 billion in the same period last year.

ECBs are commercial loans raised by eligible resident entities from recognised non-resident entities. The RBI regulates such borrowings by defining parameters such as minimum maturity, permitted and non-permitted end-uses and a maximum ceiling on interest rates at which funds can be raised.

The increasing preference for ECBs can be attributed to a number of factors, said Madan Sabnavis, chief economist at CARE ratings.

A change in rules for both domestic and overseas borrowings is playing a part in corporates looking offshore for funding.

Domestically, the Reserve Bank of India’s large exposure framework kicked in fully starting April 2019. The RBI has also tightened rules for working capital availed from local banks. These regulatory changes, together with the prevailing risk-averse sentiment across Indian banks, meant that raising funds from the local market remains cumbersome and, in some cases, expensive.

In contrast, the RBI has eased rules for external commercial borrowings, most recently by reducing restrictions on the end use of such funds. Earlier in January, the RBI had also expanded the pool of eligible borrowers and lenders. The easing of foreign borrowing rules has coincided with a global environment where interest rates are easing and ample liquidity has left investors searching for yield.

Madhavi Arora, economist at Edelweiss Securities, said the trend of increased foreign borrowings is reflective of the domestic macro economic scenario. More accommodating rules for external borrowings and tighter domestic funding regulations have led to more companies going overseas. “The RBI’s large exposure framework is one factor that had led corporates moving abroad for fulfilling funding requirements,” Arora said.

While not strictly comparable, data on domestic bank borrowings by large corporates shows that these have remained below external commercial borrowings for the last three years. To be sure, domestic bank credit growth for the last three years has been weak due to the overhang of bad loans and a larger proportion of domestic borrowing has moved to the local debt markets.

Risks Involved

While external commercial borrowings do offer firms an alternative when domestic funding markets are tough, the option comes with currency risk attached.

In the past, Indian firms have taken a hit due to unhedged foreign borrowing in times of currency volatility. In 2014, the RBI put out regulations asking banks to monitor the extent of unhedged foreign currency exposure of clients and told lenders to provide more against such accounts.

While this was intended to protect the banking system from risks associated with unhedged external borrowings, the RBI could do little to force companies into hedging. “While banks prefer companies to hedge their exposure due to RBI guidelines, there are loopholes in the form of various exceptions which companies use,” said Arora.

Data on the extent of unhedged foreign currency borrowings is not available. A large number of these companies are still not opting to hedge because the exchange rate is currently and hedging would add to costs, said Sabnavis.

While individual firms may be exposed to foreign currency risks, the RBI has now set a prudential limit for external commercial borrowings to limit volatility for the broader economy.

In a notification in December 2018, the RBI said the stock of external commercial borrowings will be restricted to 6.5 percent of the GDP. The limit, since it is linked to the country’s GDP, will be a dynamic one.

Outstanding foreign commercial bank loans stood at Rs 6.6 lakh crore as on March 2019, according to the latest external debt report. Outstanding borrowings through bonds or securities amounted to Rs 2.07 lakh crore in the same month.