External Commercial Borrowings (ECB) comprises money that has been borrowed from foreign sources for financing commercial activities in India. The Government of India permits ECBs as a source of finance for Indian Corporates for expansion of existing capacity as well as for fresh investment.
Lower interest rates prevailing in the international financial markets, longer maturity period for repayment of borrowings are the reasons which induce the corporates to borrow money from foreign sources.
However the recent volatility of rupee on account of global factors has hit ECBs. As per RBI data, the ECBs reported a drop of 32.5% on a Y-o-Y basis in July 2015. On an M-o-M basis too, ECBs recorded a fall of 32.16%.
The rupee has depreciated by 5.5% since the start of 2015. The more the rupee depreciates, the higher is the amount that the corporates need to repay the loans. The volatility in global markets was due to factors like the Greece crisis, speculation over rate hike by the US FED and recent devaluation in currency by China. These factors have kept rupee on the edge.
ECB borrowings were down because the arbitrage between rupee borrowing and dollar borrowing is disappearing. This is mainly because of higher hedging costs. Some corporates have already borrowed loans via ECBs without opting to hedge the currency. These corporates are facing trouble to repay the loan due to rupee depreciation. Besides this there is also a drop in the credit quality of Indian companies. As a result overseas lenders have been skeptical in lending to Indian corporates. As a result ECBs are likely to go further down in the next few months.
With interest rates near zero in the western world, Indian firms were on a borrowing binge! From US$ 60.3 bn in 2008, the total ECBs outstanding has reached US$ 170.8 bn in 2014 as per a report in the Mint. But even worse is the fact that most of this exposure is unhedged. If US interest rates were to rise and the rupee was to come under pressure, we believe this could lead to a huge pile up in debt.
Therefore companies with huge external borrowings need to be closely watched, due to currency volatility.