After long time there is an upward movement in IT companies’ scrip. This is primarily due to recent changes made in norms of External Commercial Borrowing (ECB). IT companies are hit badly as there top line consists of a major chunk of exports. Since most of their clients are foreign based, stronger rupee has lead to good deal of foreign exchange loss to IT companies. Two days back, finance ministry published a release in which steps are taken to control the surging rupee. In the write up below, pros and cons of the changes made in ECB norms are analyzed.

External Commercial Borrowing as the name suggests are an additional source of finance for corporate sector to facilitate expansion, fresh investment etc The policies and the upper limit for such borrowings are framed by three regulatory bodies – RBI, Finance ministry and the Government of India .

First of all let us look into the unrest which brought this press release and the sole motive which is intended behind it.

As rupee is trading at all time high of this decade, foreign currency is pumping into India like never before. The interest rates offered by Indian banks are too high as compared to other countries. This has led to an arbitrage opportunity for foreign investors and they are lending more and more money to Indian corporate in order to earn better interest. On the other hand, foreign currency is coming cheap in comparison with rupee which makes Indian corporate prefer foreign loan to Indian loans. Gradual and consistent hike in CRR brought about by RBI in the last one year is responsible for surging interest rates in India.

If we see it from the point of RBI, increased flow of foreign currency is a matter of concern. In order to maintain the balance, for every foreign currency that flows into market, RBI is bound to release an equal amount of Indian currency. So, what is the problem in doing that? As inflation is also going through the roof and purchasing power is soaring, RBI can not afford to release more and more rupee into Indian market. This will add more fuel to inflation and the situation which is in control after a long time may worsen. Hence, the ECB press release is issued with immediate effect, curbing the borrowing limit to $ 20 million for rupee expenditure.

Why there is sudden upward movement in IT stocks and what is making IT companies happy despite the fact that they will be required to borrow from India where interest expenditure is high compared to external borrowing?

This is good question and must be troubling you that IT companies need to be worried in spite of rejoicing due to higher interest expenditure. I feel they have every reason to be happy as this press release will limit the flow of foreign currency in India and will be helpful in making rupee weaker against foreign currencies. On the other hand this will mean more money for them as 60% of their revenue comes from exports and they want rupee to be tremble against foreign currency. Secondly, wage inflation and cost of operations will also come down which will further help in improving the operational margin which is slumping for almost all the IT companies.

New guidelines for ECB

ECB up to $20 million per borrowing company can be borrowed for rupee expenditure and that too with prior approval of the Reserve Bank
ECB above $ 20 million per borrowing company can be borrowed for foreign currency expenditure under automatic route. Secondly, ECB needs to be parked overseas and cannot be remitted to India in case it is borrowed for foreign currency expenditure.
All other aspects of ECB policy such as $ 500 million limit per company per year under the Automatic Route remain the same.
The above modifications are not applicable to borrowers who have already entered into the loan agreement.
Basically there are four parties who will share the gain or loss due to above modification in ECB norms namely RBI, Corporate, Markets and Banks. Let us look at each of them in details:

RBI

RBI will be able to bring in more financial discipline for which it is struggling since long time. The changes are brought in ECB to deter rising inflation and appreciating currency from diluting the effect of monetary policy. Curbing the limit of ECB will monitor inflow of foreign currency in Indian markets and in turn will prevent inflation and appreciation of rupee. RBI will also be absolved of taking aggressive measures like hiking CRR for which it has earned a bad name from banks.

Corporate

As interest rates in India are comparatively higher, India Inc will be required to shell out extra money for interest expenditure due to borrowing from Indian financial market. But this move is considered favorable for IT companies who are net exporter and are anxiously waiting for rupee to get weaker against foreign currency.

Markets

The good news for the market is that, yields for corporate and government bonds will increase which will force borrowers to rely on them for financial assistance in absence of ECBs. Secondly, the bottom line of companies will see a dip as interest cost is bound to increase. Once again the same may not apply to IT companies as their loss due to interest expenditure will be compensated by correction in rupee.

Banks

Huge amount of money is piled up with banks owing to interest rates which had risen sharply due to hike in CRR. As ECB route is now blocked, companies are bound to make their way to banks for loan and this will increase the profitability of banking sector. Secondly, from the view point of banks, it is no more required to invest idle money in government bonds which are offering low rate of interest and they can safely park their money into the corporate world which is not left with the option of borrowing from overseas.

Having analyzed all the sectors and line item which will bear the brunt and of course reap the fruit due to ceiling placed on External Borrowing, we can say that policy made by RBI impacts each and every individual directly or indirectly. So, when RBI makes a move, you may not have the slightest of idea and it may take millions out of your pocket or fill it with billions.

(The author is a Chartered Accountant working with TATA group and the views expressed are personal.)

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