Indian Economy
RBI Eases Hedging Norms for External Commercial Borrowings
- 28 Nov 2018
- 3 min read
The Reserve Bank relaxed norms for external commercial borrowings (ECBs) by reducing the mandatory hedging provision to 70% from the current 100%.
- The cost of hedging has gone up in the last six months with the strengthening of the dollar. As a result, the ECB route was becoming unattractive to firms.
- The move will help bring down the final cost of overseas loans for Indian firms but could leave them more exposed to volatility in the foreign exchange markets.
- The relaxed norms will apply to the ECBs with a maturity period between 3 and 5 years.
Background
- The push to increase hedging began after the global financial crisis, where unhedged foreign currency exposures led to significant losses for some firms.
- Following that experience, the RBI mandated 100% hedging for medium-term external borrowings. It also asked banks to set aside additional provisions against companies which had unhedged foreign currency exposure.
Hedging
- Hedging is a financial technique that helps to reduce or mitigate the effects of measurable type of risk from the future changes in the fair value of commodities, cash flows, securities, currencies, assets and liabilities.
- It is a kind of an insurance that do not eliminate the risk completely but mitigate its effect.
- It consists of the purchase or sale of equal quantities of the same or very similar commodities, approximately simultaneously, in two different markets with the expectation that a future change in price in one market will be offset by an opposite change in the other market.
External Commercial Borrowings
- External Commercial Borrowings is a loan availed by an Indian entity from a nonresident lender with a minimum average maturity of 3 years.
- Most of these loans are provided by foreign commercial banks buyers’ credit, suppliers’ credit, securitized instruments such as Floating Rate Notes and Fixed Rate Bonds etc.
- Advantages of ECBs:
- ECBs provide opportunity to borrow large volume of funds.
- The funds are available for relatively long term.
- Interest rate are also lower compared to domestic funds.
- ECBs are in the form of foreign currencies. Hence, they enable the corporate to have foreign currency to meet the import of machineries etc.
- Corporate can raise ECBs from internationally recognized sources such as banks, export credit agencies, international capital markets etc.
