Is the Reserve Bank of India's (RBI) current policy on External Commercial Borrowings (ECB) a case of missing the trees for the woods, so to speak? Its latest rationalisation and liberalisation of ECB norms, announced on Sunday, does give this impression. While there is no disputing that the central bank's overall emphasis on closely monitoring ECBs has kept the country's external sector in good stead (‘woods'), its shying away from revising all-in-costs ceilings (‘trees') for contracting ECBs, nevertheless, defies reason.
It is not less than 18 months since the RBI last revised the all-in-cost ceilings — referring to the maximum spreads over the six-month London Interbank Offered Rate (LIBOR) at which Indian corporates are allowed to contract ECBs.
This has been notwithstanding the recent and ongoing turmoil in global markets, particularly following the European sovereign debt woes and downgrading of some big European banks.
Among other things, it has led to a huge shortage of dollars, which, despite the S&P downgrade of US sovereign debt, remains the lone safe haven currency that all investors are scurrying to.
True, the situation now is not as grim as in 2008, when banks refused to lend at all, holding on to cash for their dear life. But reports from foreign banks and the foreign offices of Indian banks indicate that dollar funds are hard to come by. Even if available, they are at much higher spreads over LIBOR than what the existing all-in-cost ceilings permit.
IRRELEVANCE OF LIBOR
In fact, since 2008, there has been a debate among international banking practitioners on the very effectiveness of LIBOR as a relevant benchmark. This is because the bulk of interbank dealings – more so for banks of Indian origin – are taking place at spreads over LIBOR and not at LIBOR.
The transactions happening at LIBOR today are, in actual practice, few and far between. In 2008, many global banks resorted to the unethical practice of invoking the ‘market disruption' clause in loan agreements to demand a higher interest rate from corporates for existing loans, in the light of the LIBOR completely losing significance.
An honourable exception was our own State Bank of India: Its International Banking Group took a principled position then not to be a party to the invocation of this clause, even though its own cost of funds had shot up. Now, in a stark foreboding of the ‘return of 2008', the spreads over LIBOR for borrowings by banks have shot up dramatically over the past quarter.
Anecdotal evidence suggests that the spread is as high as 350 basis points (bps) over LIBOR for even three-month funds, while funds for longer tenures are simply hard to come by. This is definitely the case with Indian banks and RBI's interest would only concern Indian banks – and by extension, borrowings by Indian corporates that are syndicated, in the main, by Indian banks.
Against this backdrop, the existing all-in-cost ceilings for ECBs – at spreads over six-months LIBOR of 200 bps for trade credit, 300 bps for 3-5 year loans and 500 bps for five years and above – are inherently unviable from a lenders' standpoint and are guaranteed to keep out dollar inflows through the ECB route.
This has implications for the ability of Indian corporates – barring perhaps the Reliances or the Tatas – to access the ECB route to fund their trade finance and capex requirements and alleviate to some extent the problems on account of spiralling rupee interest rates.
POLICY STATUS
The current RBI-mandated all-in-cost ceilings, in a sense, makes any proposed raising of the annual $ 30 billion ECB cap or the go-ahead for corporates to use ECB proceeds for redemption of foreign currency convertible bonds (said to aggregate $ 4.5 billion) practically redundant.
There is an urgent need to raise the all-in-cost ceilings, especially given the rapid slide in the rupee, which has negative implications for oil companies already grappling with stubborn crude prices. Policy ‘stasis' on this front makes no sense in a volatile rupee-dollar exchange rate environment.
One could even go beyond immediately raising the currently out-of-sync all-in-cost ceilings to argue for a more dynamic rate-setting mechanism for ECBs.
There is, indeed, a conceptual inconsistency and practical fallacy in having a very dynamic rupee-rate setting mechanism cohabiting with an immutable and unchanging ECB rate ceiling.
On the contrary, the all-in-cost ceiling could potentially be used as a dynamic tool to turn the ECB tap on and off whenever the regulator requires – the ceiling being raised when we want forex inflows and vice versa.
Doubters would, of course, worry about the possible inflationary impact of huge inflows resulting from a hike in the all-in-cost ceiling. But there is already the $30 billion annual cap for the quantum of ECBs to take care of this. Besides this overall cap – which, one trusts, would have been factored in domestic money supply growth calculations – there are sectoral/purpose-tied restrictions on the utilisation of ECBs, which can also address any attendant inflationary consequences.
These concerns, at any rate, are irrelevant in the present context where inflationary pressures have more to do supply-side shortages than being fuelled by excess demand-side liquidity.
Perhaps, this is also the time to think in terms of a committee of experts that would pro-actively examine ECB rate ceilings and revising them taking into account the liquidity situation and changing rates in the international market.
Their recommendations could be the basis for RBI to periodically change its ECB all-in-cost ceilings and use it as a dynamic policy tool for regulating forex inflows into the country.