The Reserve Bank has recently eased norms for external commercial borrowings (ECBs) by lowering the obligatory hedging provision from 100% to 70%. This decision was spurred by rising hedging costs against a robust dollar, which were making the ECB channel increasingly unwieldy for companies. While the move could decrease the final cost of foreign loans for Indian businesses, it could also increase their vulnerability to fluctuations in the foreign exchange markets. The altered norms would be applicable to ECBs with maturity periods spanning between 3 and 5 years.
Background of the Hedging Norms
After the global financial crisis, numerous firms incurred considerable losses due to unhedged foreign currency exposures. This led to a heightened focus on hedging, and the RBI subsequently introduced a mandate for 100% hedging on medium-term external borrowings. In addition to this, banks were required to allocate additional provisions against firms holding unhedged foreign currency exposure.
Understanding Hedging
Hedging is a financial measure that aims to decrease or ease the impacts of quantifiable risks from future alterations in the fair value of a variety of commodities, cash flows, securities, currencies, assets, and liabilities. It serves as a form of insurance that does not completely eradicate the risk but mitigates its effects. The methodology involves buying or selling equal quantities of the same or similar commodities in two different markets almost concurrently, with the expectation that a future price change in one market will be counterbalanced by an opposing change in the other.
What are External Commercial Borrowings?
An ECB is a loan taken by an Indian entity from a non-resident lender, typically with a minimum average maturity period of three years. These loans are predominantly offered by foreign commercial banks and may include buyers’ credit, suppliers’ credit, and securitized instruments such as Floating Rate Notes and Fixed Rate Bonds.
| Fact | Detail |
|---|---|
| ECB Volume | ECBs provide an opportunity to borrow a large volume of funds. |
| Term of ECBs | The funds are available for a relatively long term. |
| Interest Rate | Interest rates are lower compared to domestic funds. |
| Form of ECBs | ECBs are in the form of foreign currencies. |
| Sources of ECBs | ECBs can be raised from internationally recognized sources such as banks, export credit agencies, and international capital markets. |
Advantages of External Commercial Borrowings
ECBs come with multiple advantages. They not only enable a company to borrow a hefty sum of money but also offer a relatively long-term repayment period. The interest rates are generally lower than those on domestic funds. Moreover, since ECBs are in the form of foreign currencies, they equip corporates with the necessary foreign currency to import machinery and other resources. Lastly, companies can procure ECBs from globally recognized sources, such as banks, export credit agencies, and international capital markets.
