Understanding ECB, External Commercial Borrowings

External commercial borrowing

Most of you must have heard or read about ECB- external commercial borrowing. This post will get you detailed insights into ECB to help you answer ECB questions in the GK/ General Awareness section in various entrance exams and or interviews.

Why ECB?

External Commercial Borrowing is meant to help industry in a country to get loans in foreign currency. This can also be denominated in local currency. If the interest rate in countries such as Japan, United States and countries that give Euro-denominated loans is such that it is possible to use such funds Greenfield or brown-field projects in the country. Japanese loans are in Yen, US loans are in USD and for Europe it can be Euro or the domestic currencies of European countries.

The route taken

Indian organizations can borrow by taking approval from the Reserve Bank of India for a higher amount that is the limit set by the bank. In case the money to be borrowed is lower than the set limit, it can be done through the automatic route.

What is Automatic route or Approval route?

Automatic Route

  • In case of borrowing up to USD 5 Million, minimum equity of 25 percent
  • If the borrowing is more than USD 5 Million, then the condition is that of minimum equity of 25 percent and the ratio of debt to equity not exceeding 4:1.
  • Minimum Average Maturity: 3 years

Approval Route

  • Maximum amount of ECB under the automatic route is USD 5 Million.
  • The maximum amount of ECB which can be raised by a corporate is USD 500 Million during a fiscal year.

Limits for ECB from different sources:

  • External Commercial Borrowing which can be raised by a corporate is USD 500 Million or equivalent during a financial year.
  • Non-Governmental Organization engaged in micro-finance activities can raise funds only up to USD 5 Million.
  • ECB up to USD 20 Million minimum and up to USD 500 million average maturity of five years
  • Derivatives trading can be done on foreign trade exchanges using the call / put option; minimum average maturity for these securitized products of 3 years.

ECB: Raising funds

  • Bank Loans
  • Buyer’s credit / suppliers’  credit
  • Financial lease
  • Capital market instruments
  • Foreign Currency Exchange Bonds (FCEB)
  • Foreign Currency Convertible Bonds (FCCB)
  • Floating rate notes / securitized instruments / fixed rate bonds
  • Non-convertible, partially convertible or optionally convertible preference shares

Sources for ECB

  • International banks
  • Suppliers of equipment
  • Export credit agencies
  • International capital markets
  • Foreign collaborators
  • Multilateral Financial Institutions (Such as IFC, Asian Development Bank)
  • Foreign equity holders (other than erstwhile OCBs)

External Commercial Borrowing: Advantages

  • Advantages of External Commercial Borrowing are in terms of the following:
  • Interest Rate: Interest rates are low in developed countries. This is because the focus is on deflation and not inflation, unlike developing countries. Real interest rate is what matters.
  • Exchange Rate: Cheap Yen loans finance investments in emerging as well as developed economies. Quantitative Easing that is one of the policies taken up under Abenomics has not really worked in increasing the inflation but has depreciated the currency to an extent that Yen loans become cheaper.
  • Developing Country Perspective: Interest rates being high in emerging countries, funds invariably make their way to emerging economies.

External Commercial Borrowing: Requirement

  • Hedging in case of currency risk helps. If the currency depreciates significantly, then paying the debt would require paying a large sum in terms of the domestic currency.

External Commercial Borrowing has led to crises in Latin American countries, both debt and currency crises. See if you want to read do you know the financial crises reoccur? A sudden depreciation, currency adjustment or foreign currency debt can all lead to crises in emerging economies. It is a cheap source of funding though in emerging economies the currency may appreciate to an extent that imports become expensive.

Hope you find this post informative. Please share your views below in the comment.