New Delhi: Anxious that sharply rising interest rates could force companies to postpone much-needed investments, India’s finance ministry is trying to help by working towards loosening rules involving companies’ ability to raise overseas debt through external commercial borrowings, or ECBs.
The government will now try to persuade the central bank, the Reserve Bank of India, or RBI, to agree to loosening ECB rules, primarily for maturity periods of five years and above, a senior finance ministry official told Mint. This will be done when RBI and finance ministry officials meet to discuss capital market issues shortly, he added, asking not to be named.
India’s current domestic interest rate level, coupled with a relatively immature bond market, could short-circuit investment plans of companies, the official added, explaining the finance ministry’s reasons to want to push RBI to agree to ease restrictions.
LOOSENING STRINGS (PDF)
RBI officials couldn’t be reached for comment.
On 29 July, RBI, as part of its monetary policy review, hiked the cash reserve ratio, or CRR, by 25 basis points (bps) to 9%. The so-called repo rate was also revised upward by 50 bps to 9%. CRR defines the balance commercial banks need to keep with RBI. The repo rate is simply the rate at which it lends money to banks, thus infusing liquidity in the system. One basis point is one-hundredth of a percentage point.
The last time the Indian government loosened some ECB rules to help infrastructure borrowers was on 29 May.
Investment demand has been the most significant driver of India’s recent economic growth, according to the government’s Economic Survey of 2007-08. The annual economic growth in the past three consecutive years has been at least 9% or more.
In 2007, the finance ministry significantly tightened ECB rules twice—in May and August—as large foreign capital inflows made it difficult for RBI to use monetary tools at its disposal to balance the needs of exchange rate management, inflation control and economic growth.
In 2007-08, foreign portfolio investment and ECBs were the largest sources of inflows into India, amounting to $29.26 billion and $22.16 billion, respectively. Consequently, the Indian rupee appreciated relatively quickly against the dollar and money supply increased beyond the RBI’s targets, which added momentum to inflation.
However, the situation has changed since last August, the same finance ministry official pointed out. According to RBI data, foreign portfolio investors have turned net sellers, and the rupee depreciated 6.3% against the dollar since March-end to trade at Rs42.51 in late afternoon deals on Thursday.
“Some opening up (of capital inflows) would help, (and) I don’t think it will pressurize inflation up. One can afford to ease ECB norms a bit,” said D.K. Joshi, principal economist and director at the credit rating agency, Crisil Ltd.
One of the tightening measures announced by the finance ministry last year was a reduction in the spread between the London Interbank Offered Rate, or Libor, and the interest rate on ECBs, which served to squeeze some companies out of the ECB market.
Another measure announced last year was to ask companies to park money outside India and use it to buy machinery for use at home, which slowed an increase in domestic money supply.
According to a senior banker, who didn’t want be identified as he is not authorized to talk to the media, a simple way to increase access to ECBs is to widen the spread over Libor even if the money can’t be brought in. This measure would open the door to a larger number of companies, the banker said. The current spread over Libor for ECBs with a maturity period of more than five years is capped at 3.5%.
In the wake of the subprime crisis in developed countries’ financial markets, the risk attached to debt issued by companies from emerging economies such as India increased, making ECBs more expensive. However, simultaneously the six-month Libor, which is the benchmark for interest rate on ECBs, softened on account of monetary policy measures in the US.
According to Anil Ladha, head of capital markets at ICICI Securities Ltd, a top-notch Indian company, typically one with the highest domestic credit rating, could pay 1.5-2 percentage points lower on ECBs (including hedging cost) as compared with domestic debt of the same duration. The same Indian company could raise money through ECBs for a five-year period at a total cost of about 9%, Ladha said. The cost saving on an ECB for Indian companies at a slight lower level could be more than 2 percentage points compared with domestic borrowing for the same period, he added.