External Commercial Borrowings: Framework and Challenges

Introduction

Borrowing implies taking foreign currency or Indian Rupees (‘INR’) by a person resident in India from a person outside of India. Individuals in India may consider options such as foreign currency loans or external commercial borrowings (‘ECBs’) when it comes to borrowing in foreign currencies. These loans can provide access to funds in foreign currencies, which may be advantageous for businesses engaged in imports or exports or individuals looking to diversify their investment portfolio. However, it is important to carefully evaluate the risks associated with foreign currency borrowings, such as exchange rate fluctuations and potential currency mismatches. Borrowing foreign currencies in India requires the analysis of several factors impacting the borrowings, such as the exchange rate movements between the domestic and foreign currency, the regulatory framework governing the borrowings, the approval process, if any, and other factors.

The Reserve Bank of India (‘RBI’) manages foreign exchange transactions in India. In this regard, the Foreign Exchange Management Act, 1999(‘FEMA’) is the principal act[i]. Over time, the RBI has issued several regulations under the Act to keep a proper check on foreign exchange transactions since it is necessary to control such transactions to prevent capital from flowing out of the country, which may significantly adversely impact the country's economy.

One of the sub-sets in this direction is the regulation of borrowing and lending of foreign currency. Through the notification dated 17.12.2018, the RBI has consolidated and streamlined provisions relating to borrowing and lending in foreign currency and INR under the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 (‘ECB Regulations’)[ii].

The ECB Regulations outline the procedure of borrowing and lending in foreign currency by an authorised dealer (‘AD’) or any of its branches outside India and by persons other than AD, and borrowing and lending in INR by an AD and persons other than AD. This article gives insights into the detailed framework of borrowing under the ECB Regulations.

Borrowing of Foreign Currency under FEMA Borrowing & Lending Regulations

Regs. 4 and 6 of the ECB Regulations provide that a person resident in India can borrow foreign currency or INR in the following manners: -

a.  Borrowing by the Authorized dealers

Regs. 4(A) and 6(A) of the ECB Regulations speak about borrowing foreign currency and INR by an AD, respectively. AD is the person the RBI authorizes to deal in foreign securities or foreign exchange under s. 10 of the FEMA. Transactions done through AD make it easy for the RBI to keep a check on foreign exchange transactions since they maintain all the details and documents pertaining to such transactions.

Reg. 4(A) of the ECB Regulations provides that an AD can borrow foreign currency from its branch or head office outside India. Furthermore, the outside branch of an AD, which is constituted or incorporated in India, may borrow in foreign exchange in the normal course of its banking business from outside India[iii].

AD may also borrow in foreign exchange from a bank or a financial institution (‘FI’) outside India to grant pre-shipment or post-shipment credit in foreign exchange to its exporter constituent. Pre-shipment or post-shipment essentially refers to the credit extended to an importer before or after the shipment of goods. So, suppose AD is providing credit to exporters for the payment for the exported goods; in that case, AD can borrow foreign currency from a bank or a FI outside India.

Further, reg. 6(A) of the ECB Regulations provides that an AD may raise Rupee-denominated ECBs from outside India in accordance with the provisions contained in sch. I[iv].

b. Borrowing By Persons other than ADs

Reg. 4(B) of the ECB Regulations provides about borrowing foreign currency by persons other than AD. The person resident in India can borrow up to USD 250,000 or its equivalent from their relatives outside India. Moreover, a resident in India may also get loans from outside India that do not exceed USD 250,000 for studying abroad.

Additionally, a person resident in India may also borrow, whether by way of loan, overdraft or any other credit facility, from a bank situated outside India, where the export of goods or services is proposed to be made on deferred payment terms or in the execution of a turnkey project or a civil construction contract, provided the terms and conditions are in accordance with the Foreign Exchange Management (Export of goods and services) Regulations, 2015[v].

Further, reg. 6(B) of the ECB Regulation deals explicitly with borrowing the INR by persons other than AD. The person can borrow the INR from outside India through: -

• Borrowing overseas Multilateral FIs/International Development FIs, where the source of funds of such institutions is INR-denominated bonds issued outside India or resources raised domestically, or any other source as approved by the Government of India (‘GoI’) or;

• Borrowing INR from NRI/Relatives who are overseas citizens of India and cardholders outside India are subject to such terms and conditions as specified by the RBI from time to time in consultation with the GoI.

External Commercial Borrowings

ECBs are commercial loans in the form of bank loans, buyers’ credit, suppliers’ credit, and securitized investments raised by resident entities from non-resident entities for commercial purposes. ECB plays a key role in facilitating global capital to resident entities and is generally used by FIs, government entities, or companies to fund specific projects or operations when they require foreign currency for investments, expansion, or infrastructure development.

As per reg. 2(iv) of the ECB Regulations, ECB means borrowing by an eligible resident entity from outside India in accordance with the framework decided by the RBI in consultation with the GoI.

Under the ECB Regulations, AD and any other person may raise ECB in the denomination of foreign currency and INR subject to terms and conditions laid down in sch. I of ECB Regulations. Moreover, FIs set up under an Indian Act can also raise foreign exchange and INR-denominated borrowings with the GoI’s prior approval for onward lending. Such borrowings are also in the nature of ECB and, thus, subject to provisions contained in sch. I.

ECB can be raised under two routes: -

1. Automatic Route – No prior approval from the RBI or government is required for this route. All ECBs can be raised under the automatic route if they conform to the parameters described below.

2. Approval Route – In this route, RBI approval is required if the borrowing does not meet the criteria set under the automatic route. The borrowers under this route must approach the RBI with an application, i.e., Form ECB in the prescribed format through their AD Category I bank. These cases are considered in view of the macroeconomic situation, overall guidelines, and merits of the specific application. The proposal received in this route above a certain threshold limit, i.e., refixed from time to time, would be placed before the Empowering Committee, and RBI will take a final decision in the case, taking into consideration the recommendation of the EC.

ECB Framework in India

The framework governing the ECB is designed to regulate the types of borrowings allowed, the terms, and the purpose for which the borrowing can be utilized. The RBI classifies ECB into two broad categories: -

1. Foreign Currency-denominated ECB (‘FCY ECB’) – It is a loan raised by an Indian company in a foreign currency from a confirmed banking source outside India. These are generally used for large capital expenditures like infrastructure projects or business expansion and carry exchange rate risks due to currency fluctuations.

2. INR-denominated ECB (‘INR ECB’) – INR ECBs are loans raised by Indian companies from non-resident lenders, but the loan is denominated in INR. INR ECBs allow companies to borrow in rupees while the lender assumes the foreign exchange risk. These loans are governed by the RBI guidelines and are used for specific purposes such as capital expenditure, refinancing loans, or business expansion.

Parameters of Raising ECB Under the Automatic Route

ECBs raised under the automatic route must conform to the following parameters in the Master Circular[vi].

Sl. No.	Parameters	FCY ECB	INR ECB
1	Currency of Borrowing	Any freely convertible foreign currency	INR
2	Forms of ECB	Loans include bank loans, debentures/bonds/floating/fixed rate notes, trade credits beyond three years, Foreign Currency Exchangeable Bonds (FCEBs), Foreign Currency Convertible Bonds, and Financial leases.	Loans include bank loans, floating/fixed rate notes/bonds/debentures and non-convertible debentures/preference shares, trade credits beyond three years, and financial leases. Additionally, plain vanilla rupee-denominated bonds issued overseas can be placed privately or listed on exchanges as per the regulations of host countries.
3	Eligible Borrowers	All entities that are eligible to receive Foreign Direct Investments (‘FDI’), which includes: - 1.      Port trusts 2.      Units in SEZ 3.      SIDBI and 4.      EXIM Bank of India	All entities eligible to receive FDI include Registered entities engaged in micro-finance activities, viz., registered not-for-profit companies, registered societies/trusts/cooperatives, and non-government organizations.
4	Recognised Lenders	The lender should be a resident of a Financial Action Task Force (FATF) or International Organisation of Securities Commission (IOSCO) compliant country, including on transfer of ECBs. However: 1.  Multilateral and regional FIs where India is a member country will also be considered as ‘recognised lenders; 2.  Individuals as lenders can only be permitted if they are foreign equity holders or for subscription to bonds/debentures listed abroad and Foreign branches of Indian banks are permitted as recognised lenders only for FCY ECB, except for FCCBs and FCEBs.
5	Minimum Average Maturity Period (‘MAMP’)	The MAMP will be for three years. Also, please note that the call and put option, if any, shall not be exercisable prior to the completion of minimum average maturity. However, for specific categories mentioned below, the MAMP will be as prescribed below: 1. ECB raised by manufacturing companies up to USD 50 million or its equivalent per financial – 1 year. 2. ECBs raised from foreign equity holders for working capital purposes, general corporate purposes or for repayment of Rupee loans - five years. 3. ECB raised for: a.    working capital purposes or general corporate purposes and b.   on-leading by NBFCs for working capital purposes or general corporate purposes – ten years 4. ECB raised for: a.    Repayment of Rupee loans availed domestically for capital expenditure and b.   On-lending by NBFCs for the same purpose – seven years 5. ECB raised for a.    repayment of Rupees loans availed domestically for reasons other than capital expenditure and b.   on-lending by NBFCs for the same reason – ten years Please note that – i.         ECB cannot be raised from foreign branches of Indian banks ii.       The prescribed MAMP will have to be complied with strictly under all circumstances
6	All-in cost Ceiling per annum	Prepayment charge/Penal interest, if any, for breach of covenants should not be more than 2% over and above the contracted rate of interest on the outstanding principal amount and will be outside the all-in-cost ceiling.
7	End-Uses (Negative List)	The negative list, for which the ECB proceeds cannot be utilised, would include the following: a)   Investment in the capital market. b)  Real estate activities. c)   Working capital purposes, except in the case of ECB at fifth points 2 and 3 mentioned above. d)  Equity investment. e)   General corporate purposes, except in the case of ECB at fifth points 2 and 3 mentioned above. f)   Repayment of Rupee loans, except in the case of ECB at fifth points 4 and 5 mentioned above. On-lending to entities for the above activities, except in the case of ECB raised by NBFCs as given at fifth points 3, 4 and 5.
8	Exchange Rate	Change of currency of FCY ECB into INR-denominated ECB can be at the exchange rate: a)   prevailing on the date of the agreement between the parties concerned for such change or b)  at an exchange rate, whichever is less than the rate prevailing on the date of the agreement, in case it is consented to by the ECB lender.	The exchange rate shall be the rate prevailing on the date of settlement for the purpose of conversion to Rupee.
9	Hedging Provision	Entities raising ECB must comply with guidelines of hedging issued by their sectoral regulator for foreign currency exposure. Infrastructure companies must have a risk management policy that is approved by the Board and are also required to hedge 70% of their ECB exposure if the average maturity is less than five years. The designated AD Category – I bank will verify compliance and report to RBI via Form ECB 2. Key requirements for hedging: a)    Coverage: Borrowers must hedge both principal and coupon, starting from when the liability is recorded. b)   Tenor and rollover: There should not be any unhedged exposure during ECB’s term, and a financial hedge with a minimum 1-year tenor is required. Natural Hedge: It is allowed only if projected cash flows in the same currency offset ECB exposure within the same accounting year and revenues indexed to foreign currency do not qualify.	By using permitted derivative products with AD Category I banks in India, overseas investors can hedge their Rupee exposure. They can also access the domestic market through Indian bank branches abroad or foreign bank branches, which are present in India on a back-to-back basis.
10	Change of Currency of Borrowing	It is freely permitted to change the currency of ECB from one freely convertible foreign currency to any other freely convertible foreign currency as well as to INR.	Currency exchanges from INR to any freely convertible foreign currency are not permitted.

 Trade Credit

A person other than AD, a resident in India, may borrow foreign currency or INR from an overseas supplier or bank /FI to import capital or non-capital goods as permissible under the extant Foreign Trade Policy of the DGFT. This is known as the ‘trade credit’. Reg. 2(xvii) of the ECB Regulations provides that trade credit refers to the credits extended by the overseas supplier or bank /FI for imports into India in accordance with the trade credit framework decided by the RBI in consultation with the GoI.

The trade credit here includes both buyers’ credit and suppliers’ credit. Suppliers’ credit relates to the credit for imports into India extended by the overseas supplier. In contrast, buyers’ credit refers to loans for payment of imports into India arranged by the importer from an overseas bank or FI.

Trade Credits are raised to import capital and non-capital goods as permitted under the extant Foreign Trade Policy of the DGFT and to purchase capital and non-capital goods within a Special Economic Zone (‘SEZ’) or from a different SEZ. Trade credit can be tendered by overseas suppliers, banks, other FIs, foreign equity holders, and FIs in IFSC in India. It can be raised in any freely convertible foreign currency and INR. The trade credit limit is up to 50 million equivalent per import transaction for the import of capital or non-capital goods. The borrower, who is the importer here, may also provide security to the lender/suppliers, including corporate or personal guarantees as security. Further, AD Category-I banks are permitted to issue bank guarantees in favour of overseas suppliers, banks, or FIs, duly ensuring the underlying import /trade credit complies with extant norms.

Challenges in raising ECB

1. Currency Exchange Risk – The major risk associated with the ECB is currency exchange volatility. Mostly, ECBs are in foreign currency, and depreciation of the INR can significantly increase the debt repayment burden. Companies without natural hedging mechanisms are particularly vulnerable to exchange rate fluctuations.

2. Regulatory Restrictions – The ECB offers access to foreign capital, and the RBI’s strict regulatory guidelines and end-use restrictions can limit their flexibility. Companies need to comply with detailed regulations regarding tenure, interest rates, and repayment terms, which can complicate the process of raising funds.

3. High Cost of Hedging – Companies often tend to hedge their exposure to foreign currency to mitigate currency risk, but hedging can be expensive. This process raises the effective cost of borrowing, negating the advantage of lower interest rates from foreign lenders.

4. Global Economic Fluctuations – ECBs are influenced by global market fluctuations and market conditions affecting international trade, which include interest rates and economic stability in the lender’s country. Fluctuations in the global market can lead to shifts in borrowing costs, making it difficult for companies to manage their finances effectively.

5. Approval Process – For companies raising large amounts through ECB, seeking regulatory approvals from the RBI can be time-consuming and may require extensive documentation. These delays in the approval process could impact the company’s operational or expansion timelines.

Conclusion

Foreign currency borrowing can be a complex and intimidating subject, especially when making informed decisions in a country like India. With the fluctuating global economy and the ever-changing currency exchange rates, it is crucial to understand the risks and benefits involved clearly. Whether you are a business owner considering foreign currency loans or an individual planning to invest in foreign markets, having the right knowledge can make a world of difference.

ECBs provide Indian businesses an advantageous way to obtain overseas funding for expansion and development, especially in manufacturing and infrastructure-related fields. It is imperative to give due thought to both the regulatory framework and the associated dangers. While access to foreign markets and reduced loan rates are undoubtedly advantageous, businesses still need to consider the possibility of currency hazards, regulatory obstacles, and volatility in the world market.

Careful financial planning and risk management are essential for businesses looking to exploit ECBs in order to maximize the advantages and minimize the drawbacks. Although the RBI's regulatory monitoring of ECBs guarantees that these borrowings are used for beneficial reasons, businesses that depend on overseas funding nonetheless face difficulties as a result of the changing nature of the global economy.

The RBI and Indian companies must continue to be flexible in this changing financial landscape in order to guarantee that ECBs will always be a viable choice for long-term stability and growth.

End Notes

[i] Foreign Exchange Management Act 1999 (India).

[ii] Foreign Exchange Management (Borrowing and Lending) Regulations 2018 (India).

[iii] id

[iv] id

[v] id

[vi] RBI/2011-12/ 356, Master Circular No.09 /2011-12, Master Circular on External Commercial Borrowings and Trade Credits.

Authored by Maarij Ahmad, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.