Reserve Bank of India refuses overseas bond sale with bank guarantees

MUMBAI: Overseas bond sale planned by troubled firms with the backing of bank guarantees will be hit after the Reserve Bank of India curbed the practice and also laid out strict conditions for loans to overseas ventures which were used to pay back domestic loans. The central bank’s efforts to curb what some called the ‘evergreening of loans by stealth’ could boost the number of defaults in India and also keep interest rates high given that troubled firms now have to borrow locally.

Borrowing overseas for firms without bank guarantees will push up costs so much that it won’t make sense for them to borrow in US dollars at all, unless export revenues help them avoid hedging foreign exchange exposure.

"Lenders will depend on the intrinsic credit strength of the corporate so the cost will go up for them depending on a case-to-case basis," said Mohan Shenoi head treasury at Kotak Mahindra Bank. RBI last week ordered banks to desist from practices such as guarantees, stand-by-letter of credits, and letter of comfort on behalf of joint ventures, or wholly-owned subsidiaries to avoid them using the funds to repay local loans.

This practice may appear to be beneficial for banks, but they are taking a risk as they would be on the hook if the company defaults. It was seen more as postponing the problem.

“It has, however, come to our notice that some exporter borrowers are using export advances, received on the strength of guarantees issued by Indian banks, for repayment of loans availed of from Indian banks,” the central bank said last week. “This is a clear violation of our instructions except in cases where banks have received approvals under FEMA and banks are advised to desist from such practices.”

Many infrastructure companies including GMR, ABG Shipyard and Essar Steel were looking to raise funds from overseas to repay their existing rupee loans guaranteed by domestic banks. But fund arrangers feel that the move would have an adverse impact on the bank’s balance sheet more than corporates as the capital requirements will go up. “The new regulations are likely to increase the amount of reported nonperforming corporate loans. However, the increase would reflect a truer picture of bank asset quality,” said Moody’s in a report.

This will raise the cost of borrowing for Indian corporates by about 200-250 basis points in the overseas market as their ratings will not fetch them competitive rates. The ban on ECB usage for repaying rupee loans will raise the challenge for 25 corporates with refinancing requirement of .`53,200 crore and overall bank debt of Rs 2.3 lakh crore to efficiently refinance their debt if their forex earnings do not improve significantly, says India Ratings.

“The only option left with these companies is either to infuse equity or pay higher interest for rupee loans in India,” said Deep Narayan Mukherjee, senior director, India Ratings. “This may push at least some of them nearer to a situation of financial distress.”

Indian corporates were using both fund- and non-fund-based credit facilities to repay existing rupee obligations while borrower’s credit risk remained with the bank. RBI cracking the whip may lead to some fire sale of assets. “Companies who were using this window to repay existing rupee loans either have to monetise their assets, restructure loans directly with banks or through ARCs,” said Badri Narayan founder of Third Eye Capital Advisors.