India Inc. is on a borrowing spree. India Inc's growing appetite for merger and acquisitions as well as other expansion plans has fuelled a sharp jump in overseas borrowings by domestic companies. It is expected to borrow well in excess of $20 billion in 2007 via plain vanilla loans and bonds, including foreign currency convertible bonds (FCCBs). Despite a hardening in global interest rates, leading arrangers say cross-border financing will continue to remain an attractive option.

Several factors have led to the rising attractiveness of offshore borrowings. For example, a five-year loan facility for a top-rated company is currently priced at 75 basis points over the London Inter-bank Offered Rate (Libor), which is currently quoting at 4 per cent. Add on the costs for the one-year forward cover and the withholding tax, and the all-in cost works out to approximately 9 per cent. In the domestic market, a five-year borrowing would cost about 10 per cent. Also, the hike in the cash reserve ratio (CRR) to 5.5 per cent by RBI has changed the local interest rate scenario considerably. More so, as it comes on the heels of sagging deposit growth at 20 per cent and growing credit offtake crossing 30 per cent.

Tightening Noose

Call it inflation impact. The government, which is going all out to tighten money supply, is now taking a hard look at its policy on foreign borrowings. In its bid to contain high-flying inflation, the RBI has raised its short-term lending rate six times by a total of 150 basis points since January 2006. Going ahead, RBI would need to choose between a weak to stable currency and hike in interest rates to cool overheating in the domestic market.

Early indications suggest that it is unlikely to raise the ceiling on external commercial borrowing (ECB) for 2007-08 from the current $22 billion. Industry analysts believe that new sectors like housing finance companies may not be given ECB access soon. Housing finance companies and real estate developers have been pleading with the government for ECB access for quite some time.

While RBI has been under pressure from corporates to allow greater overseas borrowing, economists fear that the apex bank could end up further tightening the noose if short-term borrowings continue to surge ahead. Economists believe that if short-term borrowings surge further, RBI could even cut down the maximum limit on overseas corporate borrowings during a year.

The government's move to retain the ECB cap for 2007-08 at the current level will come as a dampener to companies, considering their large investment plans on the back of a high economic growth. However, the central bank is currently more focussed on slowing domestic demand growth and reducing inflationary pressure, wherein it would have to allow further appreciation of the rupee against the US dollar. This is despite the Indian currency having already reached near its eight-year high with an appreciation of about nine per cent to below 43 a dollar from the bottom of 47 in July last year.

Not surprisingly, just about every banker feels that interest rates can only move northwards from here on. Companies have no option but to expand the number of banks they shop with and so, too, the avenues. Observers point out that more and more mid-cap companies are borrowing in the overseas loan market as they begin to scale up.