India banned real-estate companies and others from raising funds overseas in its latest measure to curb capital inflows to fight inflation and halt the appreciation of the rupee, which is at a nine-year high.
Real-estate borrowers will not be allowed to raise medium-term debt through external commercial borrowing (ECB), said a finance ministry statement. The peak interest rate on ECBs and other longer-term foreign debt has also been pruned, the statement added.
“My first take is that the move is meant to channel money into sectors the Reserve Bank of India (RBI) considers eligible, and at the same time cut the flow to real estate sector,” said U. Venkataraman, head, treasury, IDBI Bank.
The finance ministry announced that the maximum interest rate on overseas borrowings of a duration between three and five years will now be 150 basis points over the six-month London Interbank Offered Rate (Libor), down from the earlier level of 200 basis points. In the case of borrowings over five years’ duration, the peak interest rate will be 250 basis points over the six-month Libor, a reduction from the earlier level of 350 basis points. The current six-month Libor rate is 5.37%. “By reducing spreads over Libor, the ECB flows have been effectively moderated as smaller companies will not be in a position to raise money abroad,” said Venkataraman.
“A more restrictive environment for overseas borrowing will probably reduce the magnitude of capital flows,” said Rajeev Malik, senior economist at JP Morgan Chase Bank in Singapore. “Lower inflation will shift the government’s focus to exporters’ woes owing to currency appreciation.”
ECB inflows in 2006-07 were $5.09 billion, up from the previous year’s $2.92 billion, according to RBI. The surge in ECB flows, along with that of foreign direct investment, added to the money supply in the country, resulting in a rise in inflation. Wholesale inflation rose to a two-year high of more than 6.5% earlier this year. It slowed to 5.44% in the first week of May, the government said on Friday, as an appreciating currency, higher interest rates and import tax cuts helped ease price of manufactured goods.
Companies engaged in developing integrated townships were earlier allowed to tap ECB funds to finance projects. Now, the finance ministry has closed that route. Executives in real-estate firms could not be reached for comment late Friday night.
In April, the government disallowed real-estate firms from raising money through the issue of non-convertible and optionally convertible preference shares for regular residential and commercial projects. The changes announced by the government on Friday will become effective after RBI drafts regulations in this regard under the Foreign Exchange Management Act, said the finance ministry.
Anoop Agrawal and Cherian Thomas of Bloomberg also contributed to this story.