ECB policy linked to exchange rate concerns

By Abhishek Saxena and Jyotika Khilnani,Trilegal

Last month, this column discussed the recent modifications by the Reserve Bank of India (RBI) to the External Commercial Borrowings (ECB) policy.

Abhishek Saxena, Trilegal
Abhishek Saxena

To summarize, the RBI on 7 Augustnov 2007 revised the policy restricting ECB use for incurring foreign currency expenditure.

Further, as regards ECB for rupee expenditure, a limit of US$20 million has been provided and there is an additional requirement that RBI approval has to be sought in advance of any borrowings.

Before these changes came into effect, a company was allowed to raise ECB of up to US$500 million in one year without prior RBI approval. At the same time, the money could be used for both rupee and foreign currency expenditure subject to end-use restrictions.

Commercial implications

Jyotika Khilnani, Trilegal
Jyotika Khilnani

The above modifications to the ECB policy will have a number of implications for businesses in India operating in a various different sectors.

Restrictions on the accessibility of ECBs will leave little choice for Indian borrowers but to go for more expensive domestic borrowing for their investments.

This may not only impact their profitability but also their competitiveness, both on the local market and internationally.

The new ECB norms are aimed at regulating capital inflows into the country and the appreciation of the rupee. The appreciation of the national currency has been a constant concern of the RBI due to the potential for a trade deficit caused by Indian exports becoming uncompetitive.

The appreciation of the rupee also affects the business process outsourcing (BPO) and information technology-enabled services (ITES) sectors as it has a strong impact on their profitability and competitiveness.

These latest modifications are seen by many as the end result of the RBI’s current obsession with controlling the rupee-dollar exchange rate.

This is demonstrated by the fact that policy changes are coming down the pipeline very fast.

The RBI issued a master circular in respect of ECBs on 2 July 2007 with a sunset clause of one year, effectively implying that a review would be undertaken at the end of that period. However, just one month later, the RBI issued a new policy revising the master circular along the lines discussed above.

Winners and losers

The new regulations on ECB could be good news for a number of sectors that are likely to benfit from the new norms.

Among these are BPO and ITES companies, export-oriented companies and banks, which are also likely to benefit.

A number of other sectors are, however, likely to have to deal with new challenges.

These sectors include infrastructure, construction, engineering and capital goods manufacturing.

Capital goods manufactures are presumably amongst the worst-affected by the changes.

The end-use restrictions now in place mean that for imports of capital goods, either for new projects or for modernizing or upgrading existing projects, the ECB route is still available. However, it is not available if the capital goods are to be acquired domestically.

Another sector which is going to be severely constricted due to the modified ECB norms is the infrastructure sector, which has huge funding requirements primarily for domestic expenditure.

The Power Ministry has recently sought a waiver from the applicability of the new ECB norms for the power sector so that it can use funds raised abroad for rupee expenditures. The demand has been made in view of the sector’s huge funding requirements, primarily in rupee expenditures to meet the national growth rate provided in the current 11th five year plan.

Regulatory implications

Interestingly, the RBI has not issued any separate guidelines in relation to the approval route for ECB for rupee expenditure since the above modifications.

However, informal inquiries with RBI officials suggest that existing guidelines applicable under the approval route would also apply here.

Inquiries also suggest that since the modification, the RBI is yet to grant an approval for ECB for rupee expenditure to any applicant.

The modified ECB norms are therefore being viewed as a very stringent regulatory decision.

Next month Abhishek Saxena and Jyotika Khilnani will look at the practical impact of the modified ECB policy. Trilegal is a full service law firm that advises on corporate and commercial law in India and provides commercially-oriented legal advice and services in relation to all sectors of the economy. The firm has offices in Delhi, Mumbai, Bangalore and Hyderabad and has over 80 lawyers, some of whom have experience in law firms in the United States, United Kingdom and Japan.

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