Change in foreign loan rules too little, too late?

Change in foreign loan rules too little, too late?

New Delhi: India’s third relaxation in two months in rules governing foreign loans, or so-called external commercial borrowings (ECBs), on Wednesday may end up providing no relief to cash-strapped firms, say analysts and bankers, because they may not be able to borrow at the rates prescribed by the government.

On Wednesday, India’s central bank allowed firms to borrow up to $500 million (Rs2,490 crore) at rates up to 5 percentage points more than the six-month London interbank offered rate or Libor, an international benchmark rate.

“If markets were normal, it would have been an excellent step," Anil Ladha, head of capital markets at ICICI Securities Ltd, said. “As a signal, it is (still) good."

Still, the move comes at a time when credit markets in the West have tightened over the last few months in the wake of the subprime crisis in the US that has since ballooned into a global crunch for money.

According to data from the Reserve Bank of India, Indian firms raised $1.5 billion through ECBs in the first quarter of 2008-09 compared with $6.9 billion a year ago.

“There is a lot of capital within Asia," Ashok Chawla, secretary of the finance ministry’s department of economic affairs, said in a press conference on Thursday. The finance ministry’s media statement explicitly identified telecom firms interested in bidding for 3G spectrum as a sector meant to benefit from the easier norms.

Another senior official in the finance ministry, who did not want to be named, said Indian firms had told the government that there is appetite for Indian debt among lenders in Asian financial centres such as Tokyo and Singapore.

Not everyone agrees with that. “Given sentiment toward emerging economies, including some potential blowups in Latin America (and) eastern Europe, it is difficult to see immediate interest in India paper," Rajeev Malik, Singapore-based analyst at Macquarie Securities, said. “The move, however, is positive, and should have been done earlier."

The key bottleneck in efforts by Indian firms to raise foreign loans is the escalating cost an overseas lender such as a bank would have to pay to hedge its investment in Indian debt against a possible default, investment bankers said.

The six-month Libor rate is the base for pricing ECBs. On Thursday, it was around 3.48%.

An overseas lender who loaned money to an Indian firm would hedge or protect its debt by buying an instrument called a credit default swap (CDS). In return for a premium, a CDS seller guarantees to make good the buyer’s loss in case the Indian company defaults on its debt obligation.

Mint could not independently verify CDS rates on outstanding Indian paper—the instruments are typically traded over telephone between institutions. According to investment bankers who did not want to be named, the current CDS rates on outstanding debt of ICICI Bank Ltd and Glenmark Pharmaceuticals Ltd are 700 basis points (a basis point is one-hundredth of a percentage point) and 500 basis points, respectively.

This means that if an investor holds $10 million of ICICI Bank debt, the investor would have to pay $700,000 to a CDS seller to protect itself against a possible default.

With CDS rates for Indian paper soaring, there is unlikely to be appetite for Indian paper that can, at today’s Libor rate, offer interest no higher than 8.5%, investment bankers said.

One investment banker associated with a foreign bank, who did not want to be named, said a back-of-the-envelope calculation indicated that even a top-notch Indian borrower such as the country’s largest bank, State Bank of India, might have to offer 900 basis points above Libor to place paper overseas in current market conditions.

To be sure, CDS rates and their impact on likely borrowing rates might not necessarily be entirely linked to soundness of Indian firms. The instruments are controversial, partly on account of the haziness of the market and marked drop in liquidity in their volume.

“All CDS are not reflective of credit risks," Ladha said.