External Commercial Borrowing aids Indian organizations to raise funds in foreign currencies from outside India. This can be used to bring in fresh investments. They can be availed through the automatic or the approval route.
What is External Commercial Borrowing?
ECB, or External Commercial Borrowing as it is known in its extended form, is an instrument that helps Indian firms and organizations raise funds from outside India in foreign currencies. Indian corporates are permitted by the Indian government to raise funds using External Commercial Borrowing to help the companies expand their current capacity. External Commercial Borrowing can also be used to bring in fresh investments.
The sources similar to ECBs include Foreign Currency Convertible Bonds (FCCBs) and Foreign Currency Exchangeable Bonds (FCEBs). While the main purpose for the issuance of FCCBs is to raise capital, External Commercial Borrowing applies to commercial loans that can include securitized instruments, bank loans, suppliers’ credit, buyers’ credit, and bonds that are availed from lenders that are not Indian residents. The minimum maturity of these instruments, on average, is three years.
How to Avail External Commercial Borrowing
Funds can be raised using External Commercial Borrowing either through the approval route or the automatic route. There are certain eligibility regulations created by the government for availing of finance under the automatic route. These regulations relate to amounts, industry, the end-use of the funds, etc. Companies that wish to raise finance through ECB will have to meet these eligibility criteria and funds can be raised without the need for approval.
The approval route, on the other hand, requires companies that fall under certain pre-specified sectors to get the RBI’s or the government’s explicit permission before raising funds through External Commercial Borrowing. Circulars and formal guidelines have been issued by the Reserve Bank of India for the specification of norms for borrowing.
Benefits of External Commercial Borrowing
The following are some of the main benefits of raising funds using ECB:
- The value of funds is generally lower when borrowed from external sources. For instance, some economies have a lower interest rate, and Indian firms and organizations can borrow money at lower interest rates from the Eurozone and the United States as the rates are comparatively low.
- Since the markets are larger when raising funds through ECB, companies can meet larger requirements from international players in comparison with what can be achieved through domestic players.
- External Commercial Borrowing is just a way to take a loan. It does not necessarily have to be of an equity nature, and therefore the company’s stakes will not be diluted. Borrowers can essentially raise funds without relinquishing control as debtors will not have any voting rights in the company.
- The investor base can be diversified by the borrower.
- ECB offers access to global markets so that borrowers have greater exposure to worldwide opportunities.
- ECB offers benefits to the economy as well. Inflows can be directed into the sector by the government of India, thereby increasing its growth potential. For instance, a greater percentage of funding through ECB can be allowed by the government for the SME and infrastructure industry. This aids significantly in the overall growth of the country.
- Companies can become increasingly profitable through ECB.
Disadvantages of External Commercial Borrowing
The following are the main disadvantages of raising funds through ECB:
- The company could develop a lax attitude as the funds are available at lower rates. Companies could borrow excessively due to this and it could eventually lead to higher debt on the company’s balance sheet, thereby adversely affecting financial ratios.
- Rating agencies see companies with higher debt on their balance sheets in a negative light, which could lead to a potential downgrade of such companies. Eventually, this could enhance the company’s cost of debt, thereby destroying the image of the company in the market. Furthermore, the shares of the company could also be subject to a decline in market value over a while.
- Because raising funds through External Commercial Borrowing is done in foreign currencies, the principal, as well as the interest, will have to be paid in foreign currencies. As such, the company is exposed to risks associated with exchange rates. Hedging costs may have to be incurred by the company, thereby leading the company to incur heavy losses.
Despite the fact that ECBs can be availed at lower rates, there are a number of guidelines and restrictions that must be followed. Restrictions mainly apply to the amount that can be borrowed and the maturity of the External Commercial Borrowing. Amounts in excess of $20 million will have maturity periods of at least five years. Amounts under $20 million will have maturity periods of at least three years on average. The manner in which the funds are used will also be subject to certain restrictions.
The funds borrowed through External Commercial Borrowing can be used for the expansion of companies, but borrowers cannot use the funds for onward lending, repaying existing loans, or investing in real estate. External Commercial Borrowings are among the most commonly available sources of funding, but companies are advised to exercise caution regarding the impact the borrowing can have on their balance sheets and the risks associated with exchange risks if they are to use the funds in an effective manner.