External Commercial Borrowings (ECBs) have been a useful route to raise finance for Indian companies when either international interest rates are depressed which was the case until such time the Fed started increasing rates or where domestic rates of interest are high due to inflationary concerns. While technically all companies can access this market, practically it is limited to the medium and larger companies which have a good credit standing.
The RBI basic guideline says that companies can borrow at six months LIBOR rate plus 450 bps at the upper limit for all the three tracks which pertain to the kind of borrower. With 6-months LIBOR being 2.88 percent, in effect the companies had a ceiling of 7.38 percent which compares well with MCLR of 8.30 percent (overnight) or base rate of 9.15 percent. Normally, companies would not hit this ceiling and were happy with this arrangement. A ceiling is needed because otherwise the companies would buy at a very high cost that will be onerous for the country’s forex outflows.
But the issue here is that if companies borrowed in April 2018 when the dollar was at Rs 65 but the rupee declined continuously to say Rs 72/$ when interest payments had to be made or the principal had to be repaid, then the borrower would be paying around Rs 7 more per dollar of debt service. Therefore, it was decided that the companies had to take a 100 percent hedge where they bought dollars forward so that they were insulated from the currency swings.
The 6-months forward rate is around 4.10 percent and if one were to take a full hedge for the full amount, at the LIBOR plus 450 bps ceiling rate, the cost will be above 11 percent making it unattractive unless they were able to get it at LIBOR plus 150 or 200 bps compared with base rate. The actual choice would be between this all inclusive forex rate compared with actual rate charged by domestic commercial bank.
Now companies have felt that asking companies to hedge 100 percent was a barrier especially when the rupee became stable and hence the hedging requirement became a barrier. With the government too being keen on getting the RBI to relax this clause, the central bank has decided to do the same and now their circular reads that for loans between 3-5 years, which is the most common bracket for tenure, the hedging requirement is 70 percent and not 100 percent. Therefore, the effective hedging cost with forward rate of say 4 percent now is 2.8 percent (4 percent on 70 percent of principal). This is good news for the borrowers and will incentivise more firms to borrow through this route.
The issue of hedging needs more discussion as both the parties have a legitimate concern. The central banks will be happy if there is more hedging, because in situations like we have seen, where the rupee fell by 12-14 percent, companies with high ECB rates tend to be pressurised and while seeking to repay or service their debt add to higher pressure on the demand for dollars thus exacerbating the same. Oil companies which are largest borrowers from banks hedge on the oil price, but don’t do so on dollars. Companies feel that their comparative advantage of borrowing in the ECB market gets vitiated if they have to do 100 percent hedging. The RBI has been fine-tuning this requirement regularly and what has been announced yesterday is the latest call on hedging.
Both sides are right. Ideally the proportion to hedge can be formula-driven whereby two factors can be considered. First is the movement in the rupee dollar rate. If the rate depreciates or appreciates by x percent, companies can be made to cover y percent of their exposure. This will make it automatic and predictable as companies would also know how the hedging compulsion comes in. Otherwise, with the rates moving down, i.e. more rupees being paid for dollars, a sudden announcement by the RBI to hedge more can upset plans for the companies and the chief financial officers (CFOs) have to start rethinking their accounts.
But, if the rule is that if the rupee falls by more than 5 percent since 31 March based on RBI reference rate, then the rule changes from 70 percent to say 80 percent and so on. This way the surprise element comes down.
The second condition can be company-specific where the rule says that companies which have exposures of more than say $100 million or $500 million have to hedge a fixed proportion. Alternatively, it can be stated as a proportion of overall borrowing where it is more than 50 percent or 70 percent of aggregate liabilities.
Either way, the idea is to have it more predictable so that companies can play around with their choice of borrowing. This will lower the cost and allow better flexibility for CFOs when deciding on where to borrow and how much to borrow from domestic and international markets.
The RBI's move needs to be welcomed and sounds good for ECB borrowers. This will ease pressure on cost of borrowing as well as encourage more companies to borrow from the market. But the RBI should consider a formula driven hedging policy to make it more predictable for borrowers and avoid surprises.
(The writer is Chief Economist, CARE Ratings)
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Updated Date: Nov 27, 2018 14:47:12 IST