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Project Finance : External borrowing policy: A commercial perspective

Anew external commercial borrowing (ECB) policy was notified by the Reserve Bank of India (RBI) recently, bringing in sweeping changes to the ECB framework. Some key features of the new ECB policy are:

The medium term foreign currency-denominated ECBs and the long-term foreign currency-denominated ECBs (track I and II in the earlier framework) have both been rolled into a consolidated foreign currency-denominated ECB track. The rupee-denominated bonds and the earlier masala bonds and rupee-denominated ECB (track III in the earlier ECB framework) have been merged into rupee-denominated ECB track.

The new policy allows automatic approval of ECBs of up to US$750 million by all eligible borrowers each financial year, replacing the existing sector-wise limits. Even startups are now permitted to raise up to US$3 million under the new policy.

“Eligible borrowers” now include all entities eligible to receive foreign direct investment (that is including service and trading entities) in addition to manufacturing units, ports, units in special economic zones (SEZ) and so on. The new policy recognizes limited liability partnerships (LLP) as borrowers, something that was not provided for in the earlier policy.

Eligible lenders under the new policy include residents (including private equity firms and venture capital funds) of Financial Action Task Force (FATF) and International Organisation of Securities Commissions (IOSCO) compliant nations in addition to international equity holders and Indian banks through their foreign branches and subsidiaries, regional financial institutions, and individuals.

An expanded array of lenders including private equity and venture capital funds can now provide lending to Indian entities without having to be equity holders.

End use restrictions on ECB now also apply to: (a) chit fund businesses or a nidhi company (types of non-banking finance companies), (b) plantation companies and (c) trading in transferable development rights, in addition to the earlier restrictions on capital market investments, real estate or purchase of land, construction and development of SEZs, industrial parks or integrated townships.

Additionally, repayment of rupee loans from the proceeds of a foreign exchange track II ECB under the early policy has now been discontinued except for ECBs from foreign equity holders having a minimum average maturity period of five years.

The new policy clarifies that the use of credit cards overseas would now not be considered as an ECB, as it did so earlier. The addition of a standard operating procedure for untraceable entities sets out the steps to be taken by RBI against untraceable entities defaulting in reporting requirements for eight quarters or more.

Entities falling within the definition of “infrastructure companies” will now have to comply with a reduced mandatory hedging requirement of 70% (down from 100%) under the foreign currency-denominated ECB track.

Tax perspective

For a borrower, interest paid to non-resident associated entities is deductible as expenditure of up to 30% of earnings before interest, taxes, depreciation and amortization (EBITDA) and the surplus can be carried forward to be set off for up to eight years. For a foreign lender, a tax, levied at 5% (at source), is applicable on interest paid by Indian entities on foreign currency borrowings for all loans but will be frozen till 1 July 2020 (likely to be extended further).

Additionally, the dividend distribution tax in India makes the ECB route far more attractive for Indian companies and their associates.

The withdrawal of utilization of ECB proceeds to repay domestic rupee loans may affect some sectors adversely. For example, the renewable energy sector, which is capital intensive requires funding for as long as 25 years or more.

These projects are usually funded initially by high-cost rupee loans with later switching to lower cost foreign loans as ECB lenders are wary of giving loans before the projects reach commercial production stage. This would now be difficult and forces projects to rely on high-cost rupee loan debt funding.

The ability of investors to adequately allocate risk and non-risk capital and the opportunity for borrowers to revisit their debt profile and optimize capital inflows between rupee loans, ECBs and equity funding, will open up new investment avenues, particularly with an extended widened list of eligible lenders.

The simplification of ECB regulations in the new policy will help improve the ease of doing business in India for foreign investors, lenders and borrowers.

(This article was originally published in India Business Law Journal -



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