Corpsec Hotline

Township Projects cannot borrow from overseas

The Government of India in consultation with the Reserve Bank of India (“RBI”),  has limited  the use of External Commercial Borrowings  (“ECB”), by  removing “development of integrated townships” as a permitted end-use under the ECB guidelines. Further the  all-in-cost ceilings for the amounts payable to the lenders for the ECB (which includes interest)   have been reduced by 50-100 basis points  ("bps").  The RBI has as of May 21, 2007 issued the relevant notification under the Foreign Exchange Management Act.

Background

As per the extant ECB guidelines, ECB proceeds may  be utilised only for permitted end-use, which is primarily directed towards capital expansion or overseas acquisitions. Real estate is expressly prohibited as an end-use for ECB, however the term “real estate” in the ECB guidelines was defined to exclude “development of integrated townships” as defined by Press Note 3 (2002 Series) dated January 04, 2002 issued by Ministry of Commerce & Industry. The aforesaid Press Note 3 defined  "development of integrated townships"  as inter-alia including housing, commercial premises, hotels, resorts etc. Further conditions were  also  imposed such as a minimum area  requirement of 100 acres, a minimum capitalisation and  a minimum lock-in period for repatriation of original investment.

The  notification by the RBI pursuant to the Government's press release has withdrawn  the exemption accorded to the “development of integrated township” as a permissible end-use under the ECB guidelines.

The all-in-cost ceilings (the upper limit of the cost) for borrowings  with 3-5 year  minimum average maturity period has been lowered to the rate of 150  bps  above the benchmark  6 month LIBOR ,  against 200  bps at present. Further for borrowings  with a minimum average maturity period greater than 5 years the rate has been lowered to 250  bps over  the 6 month LIBOR, as against 350  bps currently.

Analysis and Implications

The decision to prohibit Indian companies from utilising debt raised under the ECB guidelines for developing integrated townships seems to be aimed at curbing the inflow of foreign capital into the real estate sector. It is believed that the RBI and the  Government,  fear the build up of an asset bubble in the Indian real estate sector, due to the heightened interest of foreign investors and the  consequent sky-high property valuations. Further the recent steady appreciation of the rupee compounded with a spurt in the inflation may have motivated the government decision to curb the  surge of foreign investment.

It is interesting to note that this move has been quick on the heels of an earlier press release dated April 30,  2007  which characterised foreign investments in Indian companies in the form of preference shares, other than compulsorily convertible preference shares issued on or after May 1, 2007, as ECB and not foreign  direct investment  ("FDI")  and therefore issuance or transfer of the same would be subject to the terms and conditions of the ECB guidelines (please refer to our hotline on the same). Traditionally  FDI  in to the real estate sector, like investments in other sectors, was structured as quasi-equity in the form of preference shares (optionally convertible, non-convertible or partially convertible preference shares) as this brought fixed returns and an option to convert into equity. This was considered ideal for the real estate sector as long gestation periods; various regulatory approval risks made equity investments a high risk proposition. Further as the ECB guidelines prohibited real estate purchase or development as an end-use, the use of preference shares were the only instruments which could provide debt like seniority and assured returns during the gestation period of the project.

With the above mentioned restrictions on structuring of FDI as preference share, the latest press release modifying the ECB guidelines is seen as a further blow to foreign investments in to the real estate sector effectively curtailing all forms of debt or quasi-equity investments in the real estate sector.

However, companies may now be able to tap ECBs at lower rates of interest  due to the  reduction in  the all-in ceiling costs   for ECBs by 50-100  bps . The downward revisions in the existing all-in-cost ceilings, has been ostensibly stated as in view of the upgrading of the country's sovereign credit ratings.

As per the notification the changes will apply to ECBs both under the automatic and approval routes.

Sources:

• A. P. (DIR Series) Circular No. 60 "External Commercial Borrowings (ECB) – End-use and All-in-cost ceilings - Revised"

• Press release – ECB policy modified

• Press release - Guidelines for Foreign Investment in Preference Shares

Disclaimer

The contents of this hotline should not be construed as legal opinion. View detailed disclaimer.

This hotline does not constitute a legal opinion and may contain information generated using various artificial intelligence (AI) tools or assistants, including but not limited to our in-house tool, NaiDA. We strive to ensure the highest quality and accuracy of our content and services. Nishith Desai Associates is committed to the responsible use of AI tools, maintaining client confidentiality, and adhering to strict data protection policies to safeguard your information.

This hotline provides general information existing at the time of preparation. The Hotline is intended as a news update and Nishith Desai Associates neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this Hotline. It is recommended that professional advice be taken based on the specific facts and circumstances. This hotline does not substitute the need to refer to the original pronouncements.

This is not a spam email. You have received this email because you have either requested for it or someone must have suggested your name. Since India has no anti-spamming law, we refer to the US directive, which states that a email cannot be considered spam if it contains the sender's contact information, which this email does. In case this email doesn't concern you, please unsubscribe from mailing list.