RECENT CHANGES IN THE LAW RELATED TO EXTERNAL COMMERCIAL BORROWINGS FOR INFRASTRUCTURE COMPANIES

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1 A summary of recent changes made by the Reserve Bank of India to the law related to external commercial borrowings RECENT CHANGES IN THE LAW RELATED TO EXTERNAL COMMERCIAL BORROWINGS FOR INFRASTRUCTURE COMPANIES 1

2 Introduction: The Reserve Bank of India ( RBI ) have been taking active steps to encourage greater foreign lending to the infrastructure sector and allow Indian corporates borrow internationally on more favourable commercial terms than the significantly more expensive domestic debt. The RBI has also been concerned about the fact that most Indian banks have been nearing the limits which have been set on the amount that can be advanced to certain sectors and certain borrower groups. One of the steps which have been taken by the RBI is several amendments to the external commercial borrowing ( ECB ) regulations to give greater flexibility to Indian companies in the infrastrcuture sector to avail of ECBs. Whllst It is likely that at least some of the changes (refinancing of rupee loans, bridge financing, borrowings in RMB, loans from group companies of foreign equity holders) would not have the impact that they would normally have because of the requirement to obtent the consent of the RBI (which is at the best of times is an uncertain and time consuming process), it does reflect a change in the policy mindset, with the RBI specifically declaring that it would be considering applications of this nature (and therefore the chances of such applications being successful increasing manyfold). allowed Indian companies in the infrastructure sector 1 to utilize 25 per cent of fresh ECB raised by the company to refinance Rupee loans, with approval from the RBI. The borrowing needs to comply with the following conditions: (a) at least 75 per cent of the fresh ECB proposed to be raised must be utilised for capital expenditure towards a 'new infrastructure' project(s); (b) in respect of remaining 25 per cent, the refinance must only be utilized for repayment of the Rupee loan availed of for 'capital expenditure' of an earlier completed infrastructure project(s); and (c) the refinance must be utilized only for the Rupee loans which are outstanding in the books of the financing bank concerned. This will allow infrastructure companies, post completion of a project, to replace at least a part of the domestic debt with much cheaper international debt. It also allows access to additional sources to refinancing. The key changes are as follows: REPAYMENT OF RUPEE LOANS THROUGH ECB Under the previous guidelines, repayment of existing Rupee loans was not a permissible end-use for ECB. As a result long term rupee funds could be refinanced only with further rupee borrowings. The RBI has now 1 Under the ECB Guidelines, Infrastructure sector is defined as (i) power, (ii) telecommunication, (iii) railways, (iv) roads including bridges, (v) sea port and airport, (vi) industrial parks, (vii) urban infrastructure (water supply, sanitation and sewage projects), (viii) mining, exploration and refining and (ix) cold storage or cold room facility, including for farm level pre-cooling, for preservation or storage of agricultural and allied produce, marine products and meat. 2

3 [A.P. (DIR Series) Circular No. 25] The designated AD - Category I bank 2 will monitor the end-use of funds and banks in India will not be permitted to provide any form of guarantees in relation to the bridge finance. Further the AD - Category I banks are also required to verify the actual import of the capital goods by reviewing the Bill of Entry. BRIDGE FINANCE FOR THE INFRASTRUCTURE SECTOR [A.P. (DIR Series) Circular No. 26] Since ECBs have fixed minimum average maturity and tenor, it was not possible for Indian borrowers to obtain ECBs to meet short term fundng needs or to meet a gap between actual requirements and tied-up long term funding. Indian companies which are in the infrastructure sector have now been allowed to import capital goods by availing of short term credit (including buyers / suppliers credit) in the nature of 'bridge finance', with prior approval from the RBI, subject to the following conditions:- (a) (b) the bridge finance shall be replaced with a long term ECB; the long term ECB shall comply with all the extant ECB norms; and ECB FOR INTEREST DURING CONSTRUCTION The use of loan proceeds for payment of interest during construction(idc) was a complicated one, since the previous guidelines did not permit ECB proceeds to be used for payment of IDC. In case of financing where there was a mix of rupee and foreign currency debt, provisions would require to be made such that only the rupee proceeds could be used for payment of IDC. RBI has now specified that interest during construction (IDC) would be a permitted end-use for companies which are in the infrastructure sector, provided: (a) that the IDC is capitalized; and (c) prior approval shall be taken from the Reserve Bank for (b) is part of the project cost. replacing the bridge finance with a long term ECB. 2 Indian banks which are designated as Authorised Dealers by the RBI. They are responsible for ensuring compliance of foreign exchange transactions with applicable regulations. 3

4 [A.P. (DIR Series) Circular No. 27] CLARIFICATIONS IN RELATION TO ECBS FROM FOREIGN EQUITY HOLDERS Further, the RBI has now permitted that apart from the direct foreign equity holders, indirect equity holders and group companies can also advance amounts to the Indian borrower, after obtaining approval from the RBI, in the following manner: The previous guidelines permitted Indian borrowers from obtaining ECBs from foreign equity holders. A foreign equity holder to be eligible to advance an ECB under the automatic route required a minimum holding of 25% of the paid-up equity in the borrower. Further in case of ECB more than US$ 5 million, the debt-equity ration could not exceed 4:1 (i.e. the proposed ECB could not exceed the foreign equity holding by more than four times) This policy has not been further clarified and rationalized as follows: (i) The term 'debt' in the debt-equity ratio has been replaced with 'ECB liability' and the ratio will be known as 'ECB liability'- equity ratio. This is to ensure that other borrowings/debt are not considered in working out this ratio. (i) (ii) (iii) Service sector units, in addition to those in hotels, hospitals and software, could also be considered as eligible borrowers if the loan is obtained from foreign equity holders. This would facilitate borrowing by training institutions, research and development companues, miscellaneous service companies, etc; ECB from indirect equity holders may be considered provided the indirect equity holding by the lender in the Indian company is at least 51 per cent ; and ECB from a group company may also be permitted provided both the borrower and the foreign lender are subsidiaries of the same parent. (ii) In addition to the paid-up capital contributed by the foreign equity holder, paid-up capital, free reserves (including the share premium received in foreign currency) as per the latest audited balance sheet shall be reckoned for the purpose of calculating the equity of the foreign equity holder. While seeking approval from the RBI, the borrower shall ensure that the total outstanding amount of ECBs (including the proposed ECBs) from a foreign equity lender does 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 reckoned). (iii) For calculating the ECB liability, not only the proposed borrowing but also the outstanding ECB from the same foreign equity holder lender would be reckoned. [A.P. (DIR Series) Circular No. 29] ECB IN RENMIMBI 4

5 Indian companies in the infrastructure sector, have been allowed to avail of ECBs in Renminbi (RMB), under the approval route, subject to an annual cap of USD one billion. AD Category- I bank have been permitted to open Nostro accounts in Renminbi (RMB). However, banks in India have been prohibited from providing any form of guarantees for RMB borrowings. It is expected that this liberalization will add impetus to lending to Indian companies by Chinese Banks. Chinese Banks have already started becoming fairly active in advancing ECBs to Indian corporates, particularly power plants and other infrastructure projects which will be using Chinese equipment. [A.P. (DIR Series) Circular No. 30] CREDIT ENHANCEMENT FOR STRUCTURED OBLIGATIONS The existing guidelines permitted Indian companies in the infrastructure sector and Infrastructure Finance Companies ( IFCs ) 3 to obtain credit enhancement by multilateral / regional financial institutions and Government owned development financial institutions for domestic debt raised through issue of capital market instruments, such as, debentures and bonds. This policy has not been further liberalized to permit promoters of the Indian company (direct foreign equity holder(s) holding a minimum of 25 % of the paid-up capital and indirect foreign equity holder, holding atleast 51% of the paid-up capital, to provide credit enhancement for infrastructure companies. Further, all credit enhancement by all eligible non-resident entities are now permitted under the automatic route and no prior approval will be required from the RBI for such credit enhancement. [A.P. (DIR Series) Circular No. 28] ENHANCEMENT OF ECB LIMIT UNDER THE AUTOMATIC ROUTE The limit for ECBs have been enhanced from USD 500 million in a financial year to USD 750 million. Corporates in specified service sectors viz. hotel, hospital and software, can now avail of ECB up to USD 200 million or equivalent (up from US $ 100 million). However, the proceeds of the ECBs cannot be used for acquisition of land. [A.P. (DIR Series) Circular No. 27] ECBS DESIGNATED IN INDIAN RUPEES Eligible borrowers have been permitted to borrow ECBs designated in INR from foreign equity holders under the automatic/ approval route. NGOs engaged in micro finance activities can avail of ECBs designated in INR under the automatic route from overseas organizations and individuals as well. [A.P. (DIR Series) Circular No. 27] 3 IFCs are non banking financial corporations which are designated as Infrastructure Finance Corporations by the RBI. 5

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