CLSA : Change in RBI ECB Guidlines

The government has notified fresh restrictions for external commercial borrowings (incl. FCCBs) by corporates, so as to curb capital inflows.

Going forward, ECBs of >US$20m would be allowed only if expenditure (for permissible end-uses) is in foreign currency; funds raised will need to be parked overseas and cannot be remitted into India.

While ECBs of <US$20m can be raised for rupee expenditure as well, this will need prior approval from the RBI. Funds raised will need to be parked overseas until actual requirement in India.

This measure will stall ECB issuances based purely on funding cost arbitrage and thus curb capital inflows into India. In 4QFY07, commercial loans had accounted for c.40% of capital inflows; even in FY08, fresh approvals for ECBs had nearly doubled, to US$8.7bn.

The current move, though only pre-emptive in nature, follows a number of other steps that RBI has been taking to contain system liquidity.

The move will also be supportive for loan growth and lending yields for domestic banks, since the alternative of ECB funding may, in some cases, be restricted or uncompetitive (where imports are costlier).

Rates at the short-end may not move up, however, given the +Rs700bn liquidity surplus in the banking system.

While we do see near-term weakness in the rupee, the large pipeline of equity issuances in 2H 2007 will bring in significant FX in flows and create upward pressure on the rupee later in the year.

The move will boost sentiment towards IT stocks (on expectations of rupee weakness) and other exporters (including pharma); commodities such as steel, petchem, priced off import parity, will also gain.

Importers such as autos, companies with large outstanding FX liabilities (including telcos) will be losers. Capital goods could also be impacted, since the choice of imports/local supplies will also get tied- down to the means of funding to a greater extent.

Sentiment towards mid-caps is likely to be impact, given their higher reliance on FCCBs for funding.

Impact for Tech stocks Current Rupee rate: Rs40.415/$

  • CLSA assumption for rest of FY08,FY09,FY10: Rs41.00/$
  • Assumption in current Infosys guidance: Rs40.58/$
  • Assumption in current Satyam guidance: Rs40.50/$

This policy is a technical trigger for tech stocks though EPS upgrade scenario builds only if Rupee depreciates beyond Rs41/$. Based on growth and margin fundamentals, SATYAM remains our top pick and only BUY rated stock. Infosys and HCL Tech rated OUTPERFORM.

Impact on Banks Short term Positive for banks as the credit demand (which has moderated in recent months) would pick up. Effectively this would mean banks would be able to deploy their high cost deposits into profitable lending opportunities; as we had highlighted in our results round-up, incremental loan-deposit ratio has been running at just 20%.

Impact on Banks Long term As the credit demand runs strong and liquidity tightens, the lending rates may go up which while would be positive for spreads would be negative for asset quality. However, we believe RBI has a number of tools, including reversal of recent CRR hikes, to take appropriate action.

Appendix: RBI’s recent moves on monetary, exchange rate management

  • In its quarterly credit policy, RBI raised CRR by 50bps to 7% and removed the daily limit of Rs30bn on reverse-repo (absorption), its short-term liquidity management mechanism.
  • With the hike in CRR it has been able to instantly absorb part of the excess liquidity resulting from forex buying without incurring any sterilization cost.
  • With the removal of cap on the daily reverse-repo window, the RBI will be able to actively participate in the forex market and at the same time manage liquidity.

RBI has absorbed over Rs900bn from the system in just 2 days Text of RBI’s notification on ECBs As per the RBI notification,: ECB more than US$20m per borrowing company would be permitted only for foreign currency expenditure for permissible end-uses of ECB. Accordingly, borrowers raising ECB more than US$20m shall park the ECB proceeds overseas for use as foreign currency expenditure for permissible end-uses. The above modifications would be applicable to ECB exceeding US20m per financial year both under the Automatic Route and under the Approval Route."

These conditions will not apply to borrowers who have already entered into loan agreement and obtained loan registration numbers from the Reserve Bank. In early June-07, we had highlighted that strong capital inflows would drive rupee appreciation unless the RBI were to intervene through sterilization and indicated potential for hike in CRR. The key risk now is the depreciation of the US dollar against global currencies where RBI will have limited room to maneuver. The rupee has appreciated 15% against the USD over the past 12 months.

Key to CLSA investment rankings: BUY = Expected to outperform the local market by >10%; O-PF = Expected to outperform the local market by 0-10%; U-PF = Expected to underperform the local market by 0-10%; SELL = Expected to underperform the local market by >10%. Performance is defined as 12-month total return (including dividends).

Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.

  • M.Pandurangarao

    Who are the donor’s in India, we have Income tax exeamted under 35 (I)(II) Please sent the details of the DONOR’S LIST OR NAMES