Curbs on ECBs could be removed but firms must hedge forex exposure

The government and the Reserve Bank of India (RBI) will remove a complicated web of restrictions on external commercial borrowings (ECBs) by Corporate India and use the sole tool of mandatory hedging of currency risks to regulate the firms’ access to these funds, if the duo accepts the recommendations of a panel that reviewed the relevant policy as part of a larger mandate.

Calibrating the level of compulsory currency hedging, in sync with the requirements of the economy at a given time and with the underlying theme of averting a market failure, could be the only regulatory intervention in overseas borrowing by companies. The proposals of the Committee to Review the Framework of Access to Domestic and Overseas Capital Markets, if implemented, will make it  infinitely easier for firms of different sizes from diverse sectors to borrow overseas.

Such a change could not only remove the current (sectoral and company-specific) caps on ECBs but could also require the government and the RBI to desist from deciding the maximum cost of funds and barring loans from any overseas lender for, say, it being non-compliant with KYC norms. As a result of the proposed reform, the discretionary (approval) route, that lends itself to an undesirable degree of subjectivity, would automatically cease to exist.

The panel is also learnt to have recommended that the ECB access could be denied only to sectors where the FDI is banned, such as gambling, lottery business, chit funds, real estate business or construction of farm houses, manufacturing of tobacco products, atomic energy, etc. Firms in other sectors, irrespective of their sizes, profitability or whether the sector concerned was on the policy radar, will be free to access ECBs.

Even as plethora of restrictions and ceilings exist, the government and RBI have an understanding among them that the overall ECB in a year should not breach the $40-billion mark. Sources said this ceiling would remain in a transitional period before the proposed liberalisation is fully implemented; the tool of currency hedging could be used in such a way that an indirect control can be exercised on the overall ECB ceiling, when needed.

The idea behind Sahoo panel’s proposals is to use regulation only to avoid systemic risks. If too many companies have to repay at a time when the rupee is unduly weak against the US dollar or other foreign currencies in which the loans were raised, that could be a problem and the government may need to increase the level of mandatory currency hedging in such instances, the sources explained. It made little sense to use

ECB regulations as a means to incentivise one industry, say, infrastructure, or discriminate another, they added.

According to the Sahoo panel, compulsory hedging against currency volatility should be sector and firm-agnostic.

Of course, this might increase the cost of overseas loans but the panel’s objective is not to inflate the costs. “The panel has recommended that one should regulate only if there is a fear of market failure. If there is no fear of market failure, do not regulate at all, let any firm borrow from anywhere and any amount,” said a source with knowledge of the matter. “It (the panel) has suggested (currency) hedging can be mandated up to 100%, depending on the need of the hour of the economy without discriminating among sectors,” the source added.

Currently, the hedging norms are not uniform, while it is prescribed for certain sectors like micro-finance institutions, NBFCs, etc.

Official sources told FE that the High-level Committee on ECBs which comprises the finance ministry and RBI discussed the Sahoo panel’s recommendations last week. Although the proposals are likely to be accepted in principle, the implementation could be staggered.

“A gradual liberalisation of these borrowings (ECBs) is preferable,” said Radhika Rao, an economist with Singapore-based DBS Bank.

Liberalization of the ECBs could be risky if not counterbalanced by making currency hedging mandatory, she added.

Easy access

* Remove all sector- and company-specific caps on ECBs, lift curbs on source and cost of funds, scrap the discretionary (approval) route
* Make mandatory currency hedging to avert market failures the only regulatory tool
* ECBs can be denied to only the sectors where FDI is not permitted
* Don’t use ECB policy to promote/discriminate against sectors
* Let the $40-billion informal annual ECB cap remain in a transitional period