New ECB norms curb firms' borrowing

Greenfield infra projects and mid-sized companies will find it difficult to raise funds for five years and more.

The government's successive moves to curb overseas borrowings of Indian companies has meant higher borrowing costs for small and medium enterprises (SMEs) and mid-corporates, while creating an opportunity for Indian banks to step up lending to the sector in an attempt to boost their margins.

In May, the Reserve Bank of India had lowered the interest rate ceiling on external commercial borrowings (ECBs) to 150 basis points over the six-month Libor, from the earlier 200 basis points for loans of 3-5 years.

For loans over 5 years, the ceiling had been reduced to 250 basis points over the six-month Libor from 350 basis points. One basis point is one-hundredth of a percentage point.

As the ceiling was lowered on the interest rates SMEs could offer, it cramped their ability to raise funds abroad.

This had made it harder for small firms and low-rated companies to access foreign funds. The top-end SMEs had been resorting to foreign currency borrowing to balance their cost of borrowing.

With banks' raising their lending rates, companies were looking to raise funds overseas, as this reduced their borrowing costs by up to 1 per cent. The combination of both foreign and local debt enabled these companies to keep their cost of borrowing at a single digit.

"The norms have affected the ECB plans of SMEs the most. Greenfield infrastructure projects and mid-sized corporations will now find it difficult to raise funds for five years and more within the Libor plus the 250 basis point-cap stipulated by the RBI," said a private banker.

The government imposed further restrictions on ECBs earlier this month, stipulating that overseas borrowings to meet rupee expenditure would be allowed only after obtaining prior RBI approval and companies will need to keep the funds overseas till they are actually required for making payments.

ECBs above $20 million have been permitted only for foreign currency expenditure for permissible end-uses and are required to be parked abroad.

SMEs, which will be forced to resort to mainly domestic borrowing to meet their expenditure, expect their bottom lines to be adversely impacted. The borrowing cost accounts for 8 per cent to 10 per cent of the total cost of an SME.

In the last one year, most banks have increased their prime lending rates (PLR) by 250-300 basis points. The PLRs of the five largest banks have increased to 12.75-15.75 per cent from 10.25-12.75 per cent a year earlier.

PLR is the rate at which banks extend loans to their most credit-worthy customers.

Banks on the other hand, anticipate demand from mid-corporates and small and medium enterprises (SMEs) to drive their credit growth even as retail loans are losing steam.

While the proportion of personal segment advances including housing loans in State Bank of India's lending portfolio declined marginally from 23 per cent at the end of March 2006 to 22 per cent at the end of March 2007, SME advances, which do not classify as priority sector advances, increased from 7 per cent to 8 per cent over the period.

The share of top-rated corporates in the advances of the country's largest lender also declined marginally from 12 per cent to 11 per cent over the last year, while that of mid-corporates grew by 2 percentage points to 25 per cent.

Bankers expect the demand for credit to pick-up on the back of the new ECB guidelines. The growth rate in credit had slowed down to 23.4 per cent at the end of August 3, 2007, from close to 30 per cent year-on-year over the last three years.

"The credit demand usually picks up after September. But with the new restrictions, corporate demand is expected to pick up sooner than that," said the treasury head of a public sector bank.

---

TRYING TO COME WITH FUND CRUNCH

In May, the RBI and the Centre lowered the interest rate ceiling on ECBs to 150 basis points over the six-month Libor, from the earlier 200 basis points for loans of 3-5 years

In the last one year, most banks have increased their PLRs by 250-300 basis points

The PLRs of the five largest banks have increased to 12.75-15.75 per cent from 10.25-12.75 per cent a year earlier

Bankers expect the demand for credit to pick up on the back of the new ECB guidelines