Mumbai: Indian companies will increasingly look to borrow overseas in the next few months as money becomes dearer at home following the latest interest rate increase, the Reserve Bank of India (RBI) reining in loan growth at commercial banks and the local currency strengthening.
This could hit business at Indian banks as companies raise dollar-denominated funds abroad by way of external commercial borrowings (ECBs), bankers said.
“That is quite natural,” said Bhaskar Sen, chairman and managing director of Kolkata-based United Bank of India. “In certain cases, it is already happening. Business volume will come down and borrowers will either look for alternative source of funds or postpone their projects.”
On Tuesday, RBI raised its key policy rate by a more-than-expected 50 basis points (bps) to 8% to tame inflation, the 11th time it has done so since March 2010. One basis point is one-hundredth of a percentage point.
Foreign currency borrowing has been on the rise for some time. Between January and May, Indian companies borrowed $14.5 billion (Rs.63,800 crore today) through ECBs, up 28% from $11.35 billion in the same period a year earlier, according to RBI data.
The differential between Indian and overseas rates works out to 3-4% even after hedging for the dollar cost, said Ashish Parthasarthy, treasurer, HDFC Bank Ltd.
“Companies wanting to raise non-convertible debt of say Rs500 crore will have to pay interest in double digits. The same money is available in dollar terms for a tenure of three years or more at a rate 4% cheaper,” Parthasarthy said.
The ECB borrowing rate is linked to the six-month London inter-bank offer rate (Libor), currently 0.42%. Typically, Indian companies pay about 300-400 bps above Libor on such loans.
In the current scenario, even after factoring in 3-6% hedging costs, the effective rate works out to 7.5-10.5%, lower than even the base rate, the minimum lending rate at commercial banks. Firms typically pay at least a few percentage points more than the base rate, which is 9.5% at state-owned State Bank of India, the country’s biggest commercial bank.
Such decisions are also determined by other factors, said Koushik Chatterjee, group chief financial officer, Tata Steel Ltd.
“Whether foreign borrowing makes more sense than (borrowing) in India depends on where the deployment of the fund is going to be,” Chatterjee said. “If the fund is to be spent overseas, obviously it makes more sense to borrow outside. However, if the debt is going to be serviced out of cash generated from Indian operations, then it is still better to borrow locally as the all-in cost, including that of hedging, will be almost the same and the arbitrage will be much narrower.” Tata Steel does not have any fund-raising plans currently.
In May, the government had raised the headroom for companies to borrow abroad to $30 billion from $20 billion for fiscal 2011-12.
The rupee’s movement has also made overseas borrowing attractive. It hit a three-year high against the dollar on Wednesday as investors bought the Indian currency attracted by the interest rate differential. A stronger rupee benefits companies borrowing overseas. The rupee touched 43.85 against the dollar, the highest since 29 August 2008, before closing at 44.08, the strongest since 8 April 2011.
The US Federal Reserve’s target fund rate is currently 0.25%, making for a differential with the domestic rate of about 7.75%.
Banks that have raised lending rates following the RBI move include Yes Bank Ltd, ING Vysya Bank Ltd and Development Credit Bank Ltd. Others are expected to follow suit in the next few days.
Indian banks can’t compete with overseas lenders, said R.K. Bansal, executive director at state-owned IDBI Bank Ltd.
“If a company can borrow at cheaper rates abroad, then why should it borrow from the domestic market?” asked Bansal. “Indian banks are giving high rates because they are paying high rates on deposits. Given inflation staying where it is today, the situation is likely to persist.”
RBI lowered the loan growth target for Indian banks to 18% in the current fiscal from its earlier projection of 19% in a clear indication to banks that they should go slow on disbursals and thereby curtail credit demand.
Most bankers, including State Bank of India and its nearest competitor, ICICI Bank Ltd, have said there have been signs of such moderation. Year-on-year bank loan growth slowed to 19.5% in July from 21.3% in March.
Indian companies which earn receipts through exports have a natural hedge and, hence, their costs are much cheaper, making borrowing from abroad a foregone conclusion for them, said HDFC Bank’s Parthasarthy.
RBI governor D. Subbarao said on Tuesday that the central bank was not worried about the increase in dollar inflows because of the wider interest rate differential.
“That’s the way the markets operate. But there are caps on interest rates, restrictions on end use of the money and tenor. Those will ensure ECB flows are not too much,” Subbarao said.
For instance, effective January 2010, companies are not allowed to pay more than 300 bps above Libor for a loan up to five years and more than 500 bps above Libor for loans above five years.
They are not allowed to borrow abroad for tenures less than three years. Besides, only loans taken for capital expenditure, trade finance and imports qualify as ECBs.
Vardhan Dharkar, chief financial officer of KEC International Ltd, the flagship of Harsh Goenka-controlled RPG Enterprises, agreed corporate houses will be inclined to borrow from the overseas market.
“At present, around half of our debt is in foreign currency, and this may possibly increase by another 5%,” Dharkar said. “Our strategy to optimize the cost of borrowing continues and depending on the kind of project we are undertaking and the time, we will assess whether to borrow from India or outside.”