As part of its efforts to ease regulated foreign currency loans in general, the Reserve Bank of India (RBI) recently liberalized its External Commercial Borrowing (ECB) policy to bolster medium-term debt investments in the infrastructure sector.
The RBI has reduced the minimum average maturity period of loans taken out by infrastructure companies to three years, irrespective of the amount, and has exempted mandatory 100% hedging to loan facilities that have an average maturity of five years or more. It has also reduced the mandatory hedge coverage to 70% from 100% for loans that have a maturity period of between three and five years.
The changes are meant to arrest the depreciation of the rupee by causing forex inflow in demand driven sectors and reducing the compliance cost for infrastructure companies, as hedging costs may vary between 4% to 7% of the loan amount. While the rupee has strengthened marginally, it still continues to be one of the worst performing Asian currencies. No definitive data is available to ascertain if there was indeed an uptake in ECB by infrastructure companies after the liberalisation.
However, these measures, meanwhile, may lead to significant adverse consequences.
By their nature, infrastructure assets have long gestation periods and historically, ECB policies have been designed to ensure longer loan maturities. Lowering the average maturity of ECB taken out by infrastructure companies that admittedly will take longer terms to generate the income to meet these medium-term liabilities, may have a contrary effect in the long run. The extent of financial havoc that any asset-liability mismatch can cause hardly needs any elucidation – India is still reeling from one such recent collapse.
The hedging requirements imposed under the ECB policy are intended to protect against only potential market failure associated with foreign currency loans. International experience of foreign currency borrowing shows us that currency mismatch and consequent balance-sheet infirmities may pose a risk to both the borrower and the banking system, increasing systemic risks.
Most Indian infrastructure companies, in addition to having to import a substantial part of their constituents, have to purchase internationally tradeable products at “import parity pricing”, that is domestic products have to be bought at international prices. Thus, while their liabilities are in, or are pegged at, foreign currencies, the receivables are mostly in rupee. There being no natural hedge through foreign currency earnings, it becomes imperative that borrowers have robust financial hedges in case of a large-scale currency depreciation.
On this reasoning, the MS Sahoo Committee had recommended hedging to be made mandatory as a specified uniform percentage of ECBs taken by any borrower. The hedging ratio could be determined and modified, taking into account the financing needs of the Indian economy, the development of the onshore currency derivative market and the volatility in risk tolerance of global investors. While the criticality of ECB is undeniable, any hedging liberalisation should be accompanied by strong economic rationale and merely minimising compliance cost should not push us into an endemic crisis.
The Sahoo Committee had concluded that domestic infrastructure companies should not be given any special dispensations under the ECB framework. With ad hoc measures like this, the RBI is probably pushing the ECB policy back to the bad situations, which the ECB Master Direction of 2016 sought to correct.
Ironically, while the RBI now permits infrastructure companies to have partially unhedged liabilities, it has prescribed incremental capital and provisioning requirements for Indian banks having exposure to such companies. This policy contradiction may further accentuate the domestic credit crunch.
India is ranked 23rd on the Arcadis Global Infrastructure Investment Index 2016, which measures the long-term attractiveness of countries as infrastructure investment destinations. India’s high economic rating is offset by its relatively poor performance in business environment, risk, infrastructure quality and overall infrastructure capacity and financial environment.
With dwindling budgetary allocations and domestic debt funding, India needs to focus on addressing these deficiencies to achieve long-term private sector debt financing. Any misplaced or myopic policies by the RBI may only heighten the risk perception of India, and thereby increase the cost of capital for companies. Unless there is a marked take up of ECBs by infrastructure companies attributable to this policy tweak, it remains to be seen whether more attractive but holistic measures need to be considered to bolster foreign debt.
Anish Mashruwala and Soumitra Majumdar are partners at J. Sagar Associates. Views are personal.
Vakrils House, 18 Sprott Road
Mumbai – 400 001, India
New Delhi | Gurugram | Bengaluru | Chennai |
Hyderabad | Ahmedabad | GIFT IFSC
Anish Mashruwala | Tel: +91 22 4341 8577
Email: [email protected]
Soumitra Majumdar | Tel: +91 22 4341 8535
Email: [email protected]