Curbs squeeze foreign borrowing by Indian firms

Foreign currency loans must now be raised at an all-in cost of between 150 and 300 basis points over six-month Libor as against 300bp to 0bp over Libor earlier. Also, in the case of loans of over $50 million, borrowers must use the money either to finance imports or to meet the foreign exchange costs of infrastructure projects.

The new rules mean only top-rated Indian companies can access the syndicated bank loan market, if at all, while they specifically bar Indian banks and finance companies from raising foreign currency loans or providing guarantees and credit enhancement to companies wanting to raise such loans.

The notification by the finance ministry points out that the new measures are "for a temporary period until further review". Yet Indian authorities are clearly uncomfortable with what they call "debt-creating capital inflows". Foreign debt, particularly short-term debt, has been kept on a tight leash ever since the country's balance of payment crisis in 1991. That was caused in large part by a sudden pull-out of dollar deposits from banks. The Asian crisis of 1997 highlighted the dangers of foreign currency liabilities. Ironically, the situation today is dramatically different. India has a war chest of $90 billion in forex reserves and the central bank is trying to stem the inflow of forex to keep the rupee from rising too fast.

Low interest rates abroad and an appreciating rupee encouraged a rush of Indian borrowers to tap the syndicated loan and bilateral loan market in recent months. Top Indian companies such as IPCL, Hindustan Zinc and HDFC, the biggest home mortgage finance company, were among them. "There was a cost advantage of around 300 to 400 basis points between the hedged cost of dollars and rupee interest rates," says Amit Desaria of ING Vysya.

The five-year bullet $100 million loan by IPCL in August, arranged by ANZ Investment Bank and State Bank of India, was raised at an all-in cost of just 141bp over six-month Libor and will be used to refinance the company's rupee and forex loans. A $125 million loan for Hindustan Zinc closed on October 31, just days before the new rules came into force, and will part finance the company's expansion plans.

Indian banks too have been keen to raise foreign loans, partly because the central bank capped interest rates offered by Indian banks on foreign currency deposits in October. This caused a slowdown in their foreign currency deposits. Faced with a growing demand for dollars at home, Bank of Baroda and Bank of India among the Indian banks as well as several home loan and consumer finance companies lined up to borrow abroad. These financial intermediaries cannot access the market under the new rules. Only banks that need to raise foreign loans for the government's plan to restructure the Indian textile and steel industries can do so.

Indian companies are also being urged to borrow in rupees, partly because local banks have an abundant supply of rupee deposits. But top-rated Indian companies continue to seek foreign currency liabilities even though the loan market is now closed.

Some have chosen to tap the more expensive international bond markets instead. Petrochemicals and telecoms conglomerate Reliance, for example, had its proposal to raise a foreign currency loan turned down by the government in October. Bankers say that Reliance, India's largest private company, will now go to the bond market with a $750 million offer soon. ICICI Bank wanted to raise a forex loan but eventually sold $300 million of convertible bonds to foreign investors.

Companies naturally want to borrow capital at a lower cost. Have the Indian authorities over-reacted? Bankers point out that the syndicated bank loan market for Indian borrowers is small given India's sub-investment grade rating, and most international banks are near their country limits for India. Even official figures indicate that the sum of such loans in the past year is less than $2 billion.

Softer measures, such as asking borrowers to hedge their forex risks completely, could have curbed imprudent borrowing by Indian companies, they add. Imposing capital controls will only distort capital flows. The more effective course would be to make sure market participants know and cover their risks adequately.