Introduction
The Reserve Bank of India (“RBI”), in its mid-year review of the external commercial borrowings policy (ECB) has issued various circulars. Continuing the thrust to promote Indian infrastructure and to secure long term viable funding for the sector, a significant portion of the policy initiatives is geared to support the infrastructure sector and to reduce stress on Indian Banks doing ‘rupee’ lending to support domestic infrastructure projects.
Perhaps with a view to ensuring that the proposed benefits are appropriately applied, the predominant numbers of measures are under the regulatory approval route as opposed to the automatic route, which is more self-regulated.
An overview and brief analysis of the policy initiatives is set out below:
Back to top
Policy incentives specific to the infrastructure sector
A.P. (DIR Series) Circular No. 25 - Dated September 23, 2011 - ECB for the Infrastructure Sector – Liberalisation.
Indian companies in the infrastructure sector are now allowed to utilise 25 per cent of the fresh ECB raised towards refinancing of the Rupee loan/s availed by them from the domestic banking system, under the approval route, subject to (i) at least 75 per cent of the fresh ECB proposed to be raised being utilised for capital expenditure towards a “new infrastructure project”; (ii) the remaining 25 per cent being utilised only for repayment of the Rupee loan availed for “capital expenditure” of earlier completed infrastructure project(s); and (iii) the refinance being utilised only for the Rupee loans which are outstanding in the books of the financing bank concerned.
Applications are to be submitted inter alia along with (a) certificate from the designated AD Category I bank (AD Bank) containing the details of the project(s) completed, (b) certificate from the statutory auditor confirming the utilisation of Rupee term loans with respect to “capital expenditure”; for the completed infrastructure project(s), accompanied by a certification of the domestic lender bank(s), and (c) details of the proposed ‘end use’ of the new infrastructure project.
Furthermore, the AD Bank will be required to monitor the end use of such borrowings. Credit enhancement through guarantees by domestic banks is not permitted.
This proposal seems to be a variation of the ‘take out’ finance circular issued in July, 2010. Given the background of the ‘take out’ finance circular not gathering significant traction amongst offshore lenders, the present proposal appears to have been somewhat scaled down.
However, proposals in the Circular do raise several questions, key amongst them:
(a) is this policy initiative only applicable to domestic banking companies and therefore excludes the wider non banking financial institutions community, such as Infrastructure Finance Companies and like non banking financial companies, Insurance Corporations such as Life Insurance Corporation of India, who are significant lenders to the Infrastructure Sector. From the language, it appears to be limited to domestic banks.
(b) What would constitute a ‘new infrastructure project’, and would it cover the phased e implementation of a project, most commonly seen in LNG facilities, thermal or gas power plant coupled with transmission units?
(c) When will a infrastructure project be regarded as a “completed” project, e.g. would commercial operations date be a satisfactory marker or a certification by the lender’s independent engineer be considered satisfactory for meeting this requirement?
(d) The extant ECB Guidelines define the permitted end use of the offshore borrowings. However, the Circular appears to introduce another ‘end use’ filter, which is that of the project itself, without elucidating requirements for meeting this criterion.
(e) Commercially, for interested offshore lenders there would be other issues such as nature of participation- Common Loan Agreement or Multiple Loan Agreements with a bridge, sharing of/participation in the security package, enforcement rights (given that domestic banks have the advantage of the SARFAESI Act), which would need to be appropriately negotiated.
Given that any proposals for such limited ‘refinancing’ are subject to regulatory approval, the commercial effect of these proposals will depend on how they are implemented. Clearly, the policy initiative has significant potential, especially for infrastructure heavy companies, such as power, telecommunications, roads, ports, airports etc. An even handed and commercial approach by all parties involved would be necessary for it to enjoy greater success than the take out finance initiative.
A.P. (DIR Series) Circular No. 26 – Dated September 23, 2011 - ECB - Bridge Finance for Infrastructure Sector.
Indian companies in infrastructure sector are allowed to import capital goods by availing of short term credit (including buyers/suppliers credit) in the nature of ‘bridge finance’ under the approval route, subject to (i) the bridge finance being replaced with a long term ECB; (ii) the long term ECB complying with all extant ECB norms; and (iii) prior approval shall be sought from RBI for replacing the bridge finance with a long term ECB.
This is another policy initiative with significant commercial potential, as companies quite often in the ordinary course of business seek recourse to short term funding from various sources, while awaiting financial closure for their long term funding requirements. Such short term funding is generally a financial disincentive for the borrower (and in some cases, the lender) owing to service costs. This initiative appears to allow rollover of such short term funding into long term debt.
However, what constitutes ‘bridge finance’ has not been clearly detailed. It would be important to achieve clarity on the following issues, for the initiative to be appropriately effectuated:
(a) What constitutes bridge finance- would it be a larger universe than trade credit? Could it possibly include equity or quasi equity financing? While the language would seem to suggest that the application would be wider, repayment of equity financing is likely to be a challenge.
(b) Would it be applicable to rupee denominated obligations?
(c) Who is allowed to provide bridge finance- would it include domestic and/or offshore support from parent/group companies?
(d) Would the policy initiative be extendable to existing short term facilities?
A.P. (DIR Series) Circular No. 28 – Dated September 26, 2011 - ECB Policy - Structured Obligations for infrastructure sector
Direct foreign equity holder(s) as per extant ECB guidelines (minimum holding of 25 per cent of the paid up capital) and indirect foreign equity holder, holding at least 51 per cent of the paid- up capital, are permitted to provide credit enhancement to Indian companies engaged exclusively in the development of infrastructure and by the Infrastructure Finance Companies (IFCs), as classified by the RBI in relation to their rupee denominated structured obligations.
Credit enhancement by all eligible non-resident entities is now permitted under the automatic route and no prior approval will be required from the RBI.
A.P. (DIR Series) Circular No. 30 – Dated September 27, 2011 – ECB in Renminbi (RMB)
Indian companies in the infrastructure sector, are allowed to avail of ECBs in RMB, under the approval route, subject to an annual currency cap of USD one billion.
The approval of the RBI will be valid for a period of three months and the loan agreement should be executed within the validity period.
Thereafter the company shall submit the necessary form for allotment of a loan registration number (LRN) within 7 days (from the date of signing the loan agreement between the borrower and the lender). In case the borrower fails to obtain LRN within the above period, the approval of the RBI will stand cancelled.
RMB becomes the fifth permitted currency after USD, GBP, EUR and the Yen for offshore borrowings by Indian corporate, a clear recognition of the financial buoyancy of the Asian markets and the developing synergy between the two countries. This is a progression of the trade and economic ties, evidenced with the first retail banking presence of a PRC bank in India, earlier this year.
In the current difficult economic climate, PRC banks have made headlines recently with a number of project financing deals. Supported by the government stimulus programme, both policy and commercial banks in China have poured unprecedented levels of funding into the domestic and international financial markets in the last few years. Policy banks such as China Export-Import Bank will provide large liquidity funding for a project, which is strategically important for the PRC government. In addition to direct lending to PRC companies investing abroad or offshore projects with a Chinese element, PRC banks are also encouraged to increase their lending to foreign banks and corporations, in particular in RMB. Such shift is partially due to reduced liquidity in US dollar funds among PRC banks and is partially driven by a government-led initiative to promote the use and acceptance of RMB as a settlement currency by China’s trade partners in international businesses. Several large-scale RMB lending initiatives that we have seen in the last 24 months were concluded under various RMB currency swap schemes entered into by the PRC government with a number of countries.
There is likely to be significant demand from Indian subsidiaries/ventures of PRC companies (who would have a more comfortable global ‘foreign’ currency exposure) and could benefit from their parent/joint venture partners relationships, as well as Indian companies with a presence in the PRC, who could now leverage their banking relationships for their financing needs in India. For these Indian companies, RMB funds which can be borrowed under the newly introduced ECB scheme represent an alternative source of funding for them to meet their capital expenditure commitments. As their PRC subsidiaries will have access to RMB revenue, they can use their RMB proceeds to repay the RMB loans and therefore reduce their borrowing costs.
Funding to much-needed Indian infrastructure projects undertaken by Indian corporations will reduce the financial stress on domestic banks (the traditional lenders to the infrastructure sector) and assist in India meeting its economic growth plans. However, underwriting large infrastructure projects entails significant risks in the current uncertain economic environment outside India. With many of the western banks that are traditionally active in lending to infrastructure projects reviewing their external lending policies/commitment, RMB funding available under such schemes offers an additional capital stream for Indian banks and project sponsors. This will increase the chances of obtaining underwriting for capital-intensive infrastructure and power projects, and reduce the risks and time required to complete the underwriting. Further, security packages/credit enhancement with a PRC component could also be structured providing greater comfort to prospective Lenders.
Although the circular has signalled a positive move, it appears that the RBI is adopting a ‘wait and watch’ policy of this initiative with regard to the limitations on sectoral use and the global cap on RMB borrowings. Successful adoption, could likely lead to relaxations in the future, as in the case of increase in cap on borrowings, credit enhancement under the automatic route etc.
Back to top
Non sector specific policy initiatives
A.P. (DIR Series) Circular No. 27 - Dated September 23, 2011 - ECB - Rationalisation and Liberalisation
I. Enhancement of ECB limit under the automatic route
(i) Eligible Borrowers in real sector-industrial sector-infrastructure sector can avail of ECB up to USD 750 million as against the PRE-EXISITING limit of USD 500 million.
(ii) Corporates in specified services sectors viz. hotel, hospital and software, can avail of ECB up to USD 200 million as against the PRE-EXISITING limit of USD 100 million, subject to the condition that the proceeds of the ECBs should not be used for acquisition of land.
II. ECBs designated in INR
(i) All eligible borrowers can avail of ECBs designated in INR from foreign equity holders under the automatic/approval route, as the case may be, as per the extant ECB guidelines.
(ii) NGOs engaged in micro finance activities will, however, be permitted to avail of ECBs designated in INR, under the automatic route from overseas organizations and individuals as per the extant guidelines.
III. ECB for Interest During Construction (IDC)
Interest During Construction (“IDC”) is now considered as a permissible end-use for Indian companies in the infrastructure sector, under the automatic/approval route, with the proviso that the IDC is capitalised and is part of the project cost.
The increase in the ECB borrowing limits clearly demonstrates the appetite in India for debt funding and all the relaxations are welcome steps. The extension of permissible end use criteria is commercially relevant, given the changing needs of business.
As before, it would be important to understand the scope of IDC, especially if it is allowed for refinancing rupee denominated interest obligations.
A.P. (DIR Series) Circular No. 29 – Dated September 26, 2011 - ECB from foreign equity holders
This circular provides certain clarificationsas under:
(i) The term ‘debt’ in the debt to equity ratio will be replaced with ‘ECB liability’ and the ratio will be known as ‘ECB liability’ to equity ratio, and other borrowings/debt of the borrowing entity are not to be considered for calculation of this ratio.
(ii) In addition to the paid-up capital, free reserves (including the share premium received in foreign currency) as per latest audited balance sheet shall be considered for the purpose of calculating the equity contribution of the foreign equity holder.
(iii) Where there is more than one foreign equity holder in the borrowing company, for measuring the maximum permissible ECB allowed to such foreign equity holder, only the portion of the share premium in foreign currency brought in by such shareholder (i.e. along with the face value of the equity, its investment in the borrowing company), will be considered for calculating the ECB liability-equity ratio.
(iv) For calculating the ECB liability, not only the proposed borrowing but also the outstanding ECB from the same foreign equity holder lender is to be taken into consideration.
(v) ECB proposals from foreign equity holders (direct/indirect) and group companies under the approval route shall now be considered under the following criteria:
(a) Service sector units are considered as eligible borrowers, if the loan is obtained from foreign equity holders.
(b) ECB from indirect equity holders may be considered provided the indirect equity holding by the lender in the Indian company is at least 51%; and
(c) ECB from a group company may also be permitted provided both the borrower and the foreign lender are subsidiaries of the same parent.
(vi) The total outstanding stock of ECBs (including the proposed ECBs) from a foreign equity lender should not exceed 7 times the equity holding (either directly or indirectly) of the lender (in case of lending by a group company, equity holdings by the common parent would be counted).
In terms of point (iv) above, the policy initiative seems analogous to the provisions of credit support as provided for under the Offshore Direct Investment Guidelines, where indirect holders of equity or their group companies from India have been allowed to support their offshore venture.
Most offshore investments into India are structured through special purpose vehicles (SPVs) in tax efficient jurisdictions. Such SPV’s are generally thinly capitalised and non revenue generating entities and to undertake such funding, funds would have to traverse through various jurisdictions and multiple balance sheets from the offshore operating entities to the Indian investee company. The Circular by extending the scope of ‘equity’ holders, appears to (a) allow a more direct route, and (b) leverage different balance sheets within the group of companies.
Furthermore, the enhancement of debt participation (as opposed to equity financing) is a forward looking step, as the cost of debt is much lower than that of equity. This is an encouraging sign that the needs of business are being recognised and acted upon.
It is clearly the intent of the policy initiatives to provide greater impetus to the Infrastructure Sector, subject to regulatory oversight. While the policy initiatives are welcome, some may have benefited from greater detail, wider participation, a more expansive allowance, and perhaps, less regulation.
Back to top