As Corporates Rush For Ecbs, What Happens To Rupee Lending?

Banks will have to reset tack

A K KHANDELWAL

Executive Director,

Bank of Baroda

Corporates can raise funds through the external commercial borrowings (ECB) route for any business purpose, except for investment in the stock market.

The funds through this route are raised as per the prevailing ECB policy, which has been significantly liberalised.

However, the year 2002-03 was characterised by low demand for bank credit due to depressed economic activities.

Although the domestic lending rates have come down substantially, there is still a perceptible gap as compared to international lending rates.

During the recent few months there is unabated increase in the demand for the foreign currency borrowings by the Indian corporates.

 

With the Libor at historic lows, coupled with an extremely low forward cover cost and appreciation of the rupee, they never had it so good.

The rupee lending rates are linked with the prime lending rates (PLRs), which for most banks is around 10-11 per cent.

While AAA corporates are able to raise rupee funds from the market at around 6 per cent, other corporates are paying around PLR. As against this, borrowing in foreign currency is much cheaper.

With the Libor at around 1.25 per cent and a forward cover cost of about 1 per cent for one year, the total cost is around 3-4 per cent.

Additionally, there is the advantage of an appreciating rupee in the short run, making the proposition a bonanza for the corporates.

Forex borrowings can be availed of in the domestic market by way of FCNR (B) loans granted by the banks alternatively from the international market by way of ECBs.

At present, the FCNR (B) funds with the Indian banks are virtually exhausted due to which the pricing of such loans had gone up. As against this, abundant funds are available through the ECB route.

The ECBs affect the banks in the way that existing / potential rupee borrowings in India are translated into forex borrowings abroad.

In the absence of any avenue for deployment, these funds are then compulsorily invested in government securities at low rates of returns, thereby impacting the profits of the banks and putting further downward pressure on the deposit rates.

While the banks may be feeling the pinch, it is essential that with liberalisation and globalisation, Indian companies have every right to choose their means of financing, reduce their interest costs and improve efficiencies so as to become globally competitive and remain in business.

Although ECBs entail outflow of foreign exchange towards payment of interest, the issue may not have much impact looking to the healthy foreign exchange position of the country.

The Indian financial market is still in the state of transition and over a period of time the demand-supply forces would narrow the interest rates between rupee borrowings and ECBs.

In the meantime, banks would have to redraw their strategies to make credit available to other untapped sectors and draw up innovative lending schemes.

It is also expected that over the coming years the demand for rupee credit would go up due to the improvement in the economy, emphasis on infrastructure development and funding for divestments of public sector undertakings.

ECBs good for top firms only

B SWAMINATHAN

Senior General Manager,

ICICI Bank

The outlook for the rupee looks strong. This, compounded with inherent weakness of the dollar and the US Federal Reserve giving up its strong dollar tack has opened a unique window of opportunity for Indian corporates.

The external commercial borrowings (ECB) market is seeing top Indian companies making a beeline for locking in at low interest rates.

Economic theory says forward premiums have to be equal to the interest rate differential between two currencies. But there is significant arbitrage opportunity available in the market at present.

Current Libor is at around 120 basis points, which is lowest in last two decades. Further, premiums have crashed to its historic lows with a five-year dollar-rupee swap hovering at 3.25 per cent.

A corporate with a domestic rating of AA can access the ECB market at Libor plus 100 bps and after providing for hedging cost and withholding tax, the all-in cost would be in range of 5.5-5.75 per cent, which compares quite favorably with domestic rates of around 6-7 per cent for similar rated corporate bond.

However, the ECB window is not easily accessible. The actual borrowings under this route have been falling over the last few years due to multiple reasons.

First, the interest rate differential between the international and domestic markets has declined.

Secondly, international markets have witnessed significant credit downgrades in the last few years - making them adopt defensive lending strategies, particularly towards emerging economies.

Thirdly, lending policies of many banks in the developed countries restrict them from lending to corporates in India - due to her sub-investment grade sovereign rating.

Fourthly, quite a few of the foreign banks have hit their limits on India exposures. This, combined with full utilisation of the FCNR(B) funds with Indian banks, is acting as a dampener.

Finally, even the most eligible corporates cannot fully replace their rupee borrowings on account of the regulatory limits on size of their ECB.

While top local firms would surely participate and benefit from the current scenario, the structure of the Indian rupee lending market is heavily biased towards fairly currency insensitive items such as food credit, borrowings by government bodies and mid corporate/SME lending. In the short term, these bodies are unlikely to access international markets.

Moreover, reliance on ECB by high-end corporates will not really affect the margins for rupee lenders, as these corporates have been accessing domestic funds at very fine rates.

In fact, this can be a boost for domestic lending in mid and lower segment, as banks will be forced to look for alternative lending opportunities.

The appetite for Indian paper in ECB market is limited and some downward movement in rupee interest rates is also expected. It will culminate in vanishing of this island of arbitrage opportunity.

In fact, this will be a good learning experience for Indian financial system in our transition towards full capital account convertibility, where this kind of interest rate and credit arbitrage will be short lived.