External Commercial Borrowings (ECBs) play a significant role in any developing economy since its domestic funds are usually unable to meet growing demand, more so when the cost of domestic borrowing is higher than that of international funding. Raising ECBs by Indian residents directly adds to India’s external debt and foreign exchange exposure and therefore, the same is highly regulated by the RBI. Mismatch of tenure and usage of ECBs can be disastrous for the economy as was evident from the South East Currency Crisis. Therefore, many restrictions are placed by RBI to ensure that short-term borrowings are not used for long-term use and vice versa. Policy guidelines pertaining to ECBs have been revised from time to time. Recently, on August 1, 2005 new guidelines for ECBs have been announced. In this part, we shall discuss the provisions related to raising of External Commercial Borrowings under the automatic route of Reserve Bank of India.

External Commercial Borrowings (ECBs) are a key component of India’s overall external debt which includes, inter alia, external assistance, buyer’s credit, supplier’s credit, NRI deposits, short-term credit and Rupee debt. ECB guidelines, need to be assessed in the backdrop of various external debt sustainability indicators relevant to emerging economic needs.

External Commercial Borrowings (ECBs) are defined to include commercial bank loans, buyers’ credit, suppliers’ credit, securitised instruments such as floating rate notes and fixed rate bonds etc., credit from official export, credit agencies and commercial borrowing from the private sector window of Multilateral Financial Institutions such as International Finance Corporation (Washington), ADB, IFC, CDC etc.

Even loans from Foreign Equity Holders are considered as ECBs.

Thus ECBs mean foreign currency loan raised by residents from recognised lenders.

Financial leases and Foreign Currency Convertible Bonds are also covered by ECB guidelines.

ECBs, were governed by the Ministry of Finance. Government had issued consolidated guidelines on policies and procedures for ECBs in July, 1999. The said guidelines were amended from time to time. The Central Government had last revised these guidelines on 19th January, 2004. However, subsequently RBI had issued comprehensive Circular No. 60 dated 31st January, 2004, contents of which later on were incorporated by way of amendments to the original Notification No. 3/2002-RB vide Notification No. 126/2004-RB, dated 13th December, 2004.

From 1st February, 2004 major restrictions were imposed on raising ECBs, by Indian borrowers, such as ban on end use of ECB for working capital, general corporate purpose, cap of US$ 500 million per financial year under the Automatic Route etc. Submission of ECB-2 return to RBI on a monthly basis duly certified by the designated Authorised Dealer as well as a Chartered Accountant was made mandatory with effect from 1st February, 2004. On April, 2005, RBI permitted NGOs engaged in micro-finance activities to raise ECB under automatic route vide its Circular No. 40. The revised guidelines issued by the Government of India on 19th January, 2004 and the original comprehensive guidelines of 1999-2000 have practically become redundant in the light of these developments.

RBI has further amended its earlier ECB guidelines vide Circular No. 5, dated August 1, 2005. Notification making amendments based on these guidelines is still awaited.

ECB guidelines can be divided in three broad periods. Prior to 1st February, 2004, when there were less restrictions on raising ECB and the same was allowed for general corporate purpose including working capital requirements of companies. From 1st February, 2004 to 31st July, 2005, ECBs were governed by RBI guidelines covered by the A.P. (DIR Series) Circular No. 60, dated 31st January, 2004, which prohibited raising of ECB for general corporate purposes/working capital and imposed several other restrictions and reporting requirements. New ECB guidelines are announced by RBI effective from August 1, 2005 which imposes further restrictions in terms of percentage of shareholding by the leaders, permissible debt equity ratio and so on.

Provisions of ECB discussed in this Article are based on the latest RBI guidelines on ECB covered by Circular No. 5, dated 1st August, 2005.

There are three broad schemes — or more appropriately, following facilities under ECB schemes:

1. Trade Credit

2. Automatic Route

3. Approval Route

In this part, we will cover the first two schemes; i.e., Trade Credit and Automatic route only.

4.1 Trade credit for imports into India

Trade Credits’ (TC) refer to credits extended for imports directly by the overseas supplier, bank and financial institution for original maturity of less than three years. Depending on the source of finance, such trade credits include suppliers’ credit or buyers’ credit. Suppliers’ credit relates to credit for imports in to India extended by the overseas supplier, while buyers’ credit refers to loans for payment of imports in to India arranged by the importer from a bank or financial institution outside India for maturity of less than three years. It may be noted that buyers’ credit and suppliers’ credit for three years and above come under the category of External Commercial Borrowings (ECB) which are governed by ECB guidelines.

4.1.1 Amount and maturity

ADs are permitted to approve trade credits for imports into India up to US$ 20 million per import transaction for import of all items (permissible under the Exim Policy) with a maturity period (from the date of shipment) up to one year. For import of capital goods, ADs may approve trade credits up to US$ 20 million per import transaction with a maturity period of more than one year and less than three years. No roll-over/extension will be permitted by the AD beyond the permissible period.

As hitherto, ADs shall not approve trade credit exceeding US$ 20 million per import transaction.

4.1.2 All-in-cost Ceilings

The all-in-cost ceilings are as under:

Maturity period	All-in-cost ceilings over 6 months LIBOR*
Up to one year	50 basis points
More than one year but less than three years	125 basis points

* for the respective currency of credit or applicable benchmark.

The all-in-cost ceilings include arranger fee, upfront fee, management fee, handling/processing charges, out of pocket and legal expenses, if any. The all-in-cost ceilings will be reviewed from time to time.

4.1.3 Guarantee

ADs are permitted to issue guarantee/Letter of Undertaking (LoU)/Letter of Comfort (LoC) in favour of overseas supplier, bank and financial institution, up to US$ 20 million per transaction for a period up to one year for import of all non-capital goods permissible under Foreign Trade Policy (except gold) and up to three years for import of capital goods, subject to prudential guidelines issued by Reserve Bank from time to time. The period of such guarantees/LoU/LoC has to be
co-terminus with the period of credit, reckoned from the date of shipment.

4.1.4 Reporting arrangements

ADs are required to furnish details of approvals, drawal, utilisation, and repayment of trade credit granted by all its branches, in a consolidated statement, on a monthly basis.

ADs are also required to furnish data on issuance of guarantees/LoU/LoC by all its branches, in a consolidated statement on quarterly basis.

4.2 Automatic Route for External Commercial Borrowings up to US $ 500 million or its equivalent during a financial year

4.2.1 Permissible entities

Indian companies registered under the Companies Act, 1956 are permitted to raise ECBs up to US $ 500 million from reputed lenders in any one financial year (April to March). Financial intermediaries like banks, financial institutions, housing finance companies, NBFCs, Trusts, Non-Profit making Organisations (NPOs), Proprietorship/Partnership Concerns and Individuals are not eligible to raise ECBs under automatic route.

Non-Government Organisations (NGOs) engaged in micro finance activities are eligible to avail ECB.

4.2.2 Recognised lenders

1. The eligible entities can borrow in foreign currency by way of issue of bonds, floating rate notes or other debt instruments from following lenders:

1. International bank or international capital market, or
    

2. Multilateral financial institutions, namely, IFC, ADB, CDC etc., or
    

3. Export Credit Agencies,
    

4. Foreign collaborator or foreign equity holder as specified by RBI, or
    

5. Supplier of equipments provided the amount of loan raised does not exceed the total cost of the equipment being supplied by lender, or
    

6. Any other eligible entity as may be prescribed by RBI in consultation with Government.

2. The key operative part in the credential of the overseas lender is that ECB should be availed from an internationally recognised source and one of the recognised categories is "foreign equity holder" as indicated above. It is clarified that for a "foreign equity holder" to be eligible as "recognised lender" under the automatic route would require minimum holding of equity in the borrower’s company as under:

1. ECB up to US$ 5 million — minimum equity of 25 per cent held directly by the lender.
    

2. ECB more than US$ 5 million — minimum equity of 25 per cent held directly by the lender and debt-equity ratio not exceeding 4:1 (i.e., the proposed ECB not exceeding four times the direct foreign equity holding).

4.2.3 End use

1. ECBs can be raised only for investment in (import of capital goods, new projects, modernization/expansion of existing production units) real sector — industrial sector including small and medium enterprises (SME) and infrastructure sector in India.
   
   Infrastructure sector is defined as (i) power, (ii) telecommunication, (iii) railways, (iv) roads including bridges, (v) ports, (vi) industrial parks, and (vii) urban infrastructure (water supply, sanitation and sewage projects).
   
   It has been clarified by RBI that in order to determine what is ‘real sector’ one has to look whether there is a creation of real asset or not. Through ECBs, real asset should be a created and not merely financial asset. Thus, if one were to set up a BPO centre, acquisition of premises can be considered as end use of ECBs.
    

2. ECB can be raised for first stage acquisition of shares in the disinvestment process and also in the mandatory second stage offer to the public under the Government’s disinvestment programme of PSU shares.
    

3. ECB can be raised for direct investment in overseas JV/WOS subject to the existing guidelines on Indian Direct Investment in JV/WOS abroad. (A.P. (DIR Series) Circular No. 75 dated 23rd February 2004).

4.2.4 Restrictions on use of funds

Borrower shall not utilise the funds borrowed under any of these Schemes for

1. Investment in stock market
   However, ECB can be used for first stage acquisition of shares in the disinvestment process, and also in the mandatory second stage offer to the public under Government’s disinvestment programme of PSU shares.
    

2. Investment in real estate business
   However, investment in "Integrated Townships" as defined by Ministry of Commerce and Industry, Department of Industrial Policy and Promotion, SIA (FC Division), Press Note 3 (2002 Series, dated 4-1-2002) is permitted.
   
   It should be noted that the meaning of "Integrated township development" is different from "real estate development". Construction by a builder of a residential building or a commercial building is also real estate development. NRI investment is allowed in this sector. But ECB cannot be raised for such purpose. But if there is a project of township development (which means large projects over 100 acres of land with equity investment of at least US $ 5 million) then ECB can be raised.
    

3. On lending
   One cannot borrow to lend, except in case of investment in JV/WOS where loans also can be given. Foreign entity cannot lend in India to an Indian entity to enable the borrowing entity to invest abroad. ECB can be directly used by the borrower to invest abroad.
   
   Refinancing of ECB (i.e., raising new ECB at lower interest rate and repaying old ECB at higher interest rate) is permitted. However, outstanding maturity of the old loan should be maintained.
    

4. General corporate purpose
   ECB cannot be raised for general corporate purposes.
    

5. Repayment of existing rupee loans
   ECBs cannot be raised for repayment of existing rupee loans.

4.2.5 Amount and maturity

Reserve Bank of India has prescribed limits for minimum average maturity for ECB loans raised under the automatic route which are as under:

Amount of maturity	ECB Minimum Average
(i) Up to US$ 20 million or its equivalent	Not less than  three Years
(ii) Above US$ 20 million and upto US$ 500 million or its equivalent	Not less than  five Years

Borrowing up to US$ 20 million can have call/put option provided the minimum average maturity of 3 years as prescribed above is complied with before exercising put/call option.

The maximum amount of ECB which can be raised by a corporate is US$ 500 million during a financial year.

Average maturity is defined as "weighted average of all disbursements taking each disbursement individually and its period of retention by the borrower for the purpose of ECBs."

4.2.6 All-in-cost ceiling

The amended Schedule I to Regulation 6(1) to the Notification No. FEMA.3/2000-RB dated 3rd May, 2002 prescribes that "All-in-cost ceilings" for borrowing in foreign
exchange shall be specified by RBI from time to time.

The ceilings prescribed by RBI before the replacement of schedule is valid presently in absence of any amendment thereto. The same are as follows :—

"All-in-cost" includes rate of interest, other fees and expenses in foreign currency except commitment fee, pre-payment fee, and fees payable in Indian Rupees. All fees paid to professionals, merchant bankers, expenses paid in foreign currency are covered in the limit specified. Thus, it is annual cost limit rather than interest rate limit.

Moreover, the payment of withholding tax in Indian rupees is excluded for calculating the all-in-cost.

Minimum average Maturity Period	All-in-cost ceilings  over six month LIBOR*
Three years and up to five years	200 basis points
More than five years	350 basis points

* for respective currency of borrowing or applicable benchmark.

Thus, if LIBOR for US $ is 1%, then the rate for ECB for average maturity exceeding 5 years cannot exceed 4.5%.

RBI has clarified that all-in-cost ceiling must be calculated over a period of loan. Thus, in a first year the cost may increase the prescribed limit but as long as the average cost over the period of loan remains within the ceiling there is no problem.

4.2.7 Guarantees

Banks, financial institutions and Non-Banking Finance Companies shall not provide issue guarantee or Letter of Comfort or Standby Letter of Credit in favour of overseas lender on behalf of their constituents for their borrowings in foreign exchange.

4.2.8 Security

The choice of security to be provided to lender/supplier is left to borrower. However, creation of charge over immovable assets and financial securities, such as shares, in favour of overseas lender is subject to Regulation 8 of Notification No. FEMA 21/RB-2000 dated May 3, 2000 and Regulation 3 of Notification No. FEMA 20/RB-2000, dated May 3, 2000, respectively. In case of immovable property, a non-resident is not permitted to acquire immovable property except in limited circumstances. Therefore, for offering immovable property as a security, prior approval is necessary. Similarly for shares being offered as security, while it is possible for a non-resident to acquire shares under automatic route, under the normal circumstances, in case of security being enforced, the acquisition of shares cannot be under automatic route. Therefore it may be better to obtain prior approval from RBI.

4.2.9 Parking of ECB proceeds overseas

ECB proceeds should be parked overseas until actual requirement in India. It is clarified that ECB proceeds parked overseas can be invested in the following liquid assets (a) deposits or Certificate of Deposit or other products offered by banks rated not less than AA(-) by Standard and Poor/Fitch IBCA or AA3 by Moody’s; (b)  deposits with overseas branch of an authorised dealer in India; and (c)  Treasury bills and other monetary instruments of one year maturity having minimum rating as indicated above. The funds should be invested in such a way that the investments can be liquidated as and when funds are required by the borrower in India.

4.2.10 Prepayment

Prepayment of ECB up to US$ 200 million may be allowed by ADs without prior approval of RBI subject to compliance with the stipulated minimum average maturity period as applicable to the loan.

4.2.11 Refinance of existing ECB

Refinancing of existing ECB by raising fresh ECB at lower cost is permitted subject to the condition that the outstanding maturity of the original loan is maintained.

4.2.12 Debt servicing

The designated Authorised Dealer (AD) has the general permission to make remittances of instalments of principal, interest and other charges in conformity with ECB guidelines issued by Government/RBI from time to time.

4.2.13 Procedure

Borrower may enter into loan agreement complying with ECB guidelines with recognised lender for raising ECB under Automatic Route without prior approval of RBI. The primary responsibility to ensure that ECB raised/utilised are in conformity with the ECB guidelines and the Reserve Bank regulations/directions/circulars is that of the concerned borrower and any contravention of the ECB guidelines will be viewed seriously and may invite penal action. The designated AD is also required to ensure that raising/utilisation of ECB is in compliance with ECB guidelines at the time of certification.

4.2.14 Hedging

In cases where ECBs have been raised for meeting rupee expenditure under Automatic Route, the Authorised Dealer has to ensure at the time of draw down that the forex exposure of the borrower is hedged unless there is a natural hedge in the form of uncovered foreign exchange receivables. [A.P.(DIR Series) Circular No. 23 dated 17th September, 2002]

4.2.15 Drawal of loan

The borrower can draw-down the loan only after obtaining loan registration number from DESACS, RBI.

4.2.16 Reporting requirements

1. In order to simplify the procedure, submission of copy of loan agreement is dispensed with.
    

2. Borrowers are required to submit Form 83, in duplicate, certified by the Company Secretary (CS) or Chartered Accountant (CA) to the designated AD. One copy is to be forwarded by the designated AD to the Director, Balance of Payments Statistics Division, Department of Statistical Analysis and Computer Services (DESACS), Reserve Bank of India, Bandra-Kurla Complex, Mumbai – 400 051 for allotment of loan registration number.
    

3. Borrowers are required to submit ECB-2 Return on monthly basis certified by the designated AD so as to reach DESACS, RBI within seven working days from the close of month to which it relates.
    

4. The loan agreement entered into by the borrower with the overseas lender shall strictly conform to these Regulations.

In the subsequent part we shall discuss provisions relating to raising ECBs under the Approval Route of RBI.