Despite the fact that capital flows are embellishing the stock markets to new highs, at the same time they are drilling holes in the balance sheets of Indian companies.

For quite some time rupee appreciation due to capital inflows has been denting the bottom-line of Indian exporters; and to add insult to injury we have a new villain on the block.

With a view to stem further capital flows into the country, the apex bank - the Reserve Bank of India is contemplating a sterlisation tax on External Commercial Borrowings (ECB).

As Dharmakirti Joshi, Principal Economist, CRISIL shares his views, "Capital flows have been a big headache for the Central bank and ECBs are a major source of such inflows. The RBI incurs a cost on sterilising these inflows and in order to recover its costs it has proposed a sterlisation tax."

ECBs, which have been one of the cheapest and most preferred sources of capital for Indian companies, will get costlier once the proposal is accepted by the finance ministry and would leave companies, especially Small and Medium Enterprises (SMEs), in dire straits.

Well, ECBs have been the target of the authorities and this planned sterlisation tax ECBs comes after the decision in the month of April-May '07 that all foreign investment coming in as non-convertible, optionally convertible or partially convertible preference shares would be considered as debt.

Later in August, the RBI restricted ECB proceeds to be parked overseas for use as foreign currency expenditure to $20 million and also the cap was placed at $20 million for ECBs utilised for rupee expenditure, subject to approval by the RBI. All of this has been done with a view to discourage dependence on ECBs.

To make things worse, apart from a sterlisation tax, restricting the automatic ECB route to $20 million as against the present cap of $500 million, is also making news. Amidst all this, the small and mid-sized companies will be bearing the brunt of tougher ECB norms. Smaller companies would see their borrowing cost going through the roof as they will turn up for domestic options, which are anyway high.

"The cost of incremental rupee borrowing, which would replace the ECBs, will entail an additional cost of about 200-250 basis points per annum for a five-year term, depending on the credit rating of the companies," says Devendra Nevgi, Chief Executive officer of Quantum AMC.

But not everything seems to be as bad and there seems to be some sigh of relief on the horizon. As Dharmakirti Joshi goes on to add, "This step has been taken to discourage the ECBs and it will definitely have a negative effect on ECBs. But at the same time it all depends on the quantum of tax that's going to be levied. Moreover, a depreciating dollar will still continue to make ECBs attractive and might negate the effect of the proposed tax."

Definitely it all depends on how things turn up in the near future. The approval of the proposal and the Rupee dollar exchange rates are the events that would define what will happen to ECBs, but the implications are wide open in front of you all.

Mr. Divya Aggarwal

Money Management Consultants Ltd

Senior Copy Editor, Money Management Consultants Ltd
New Delhi, India

Free Member, Joined :05/11/2007
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