The Hindu Business Line : Brakes on ECBs

Despite its own data and that put out by the Reserve Bank of India endorsing the view that inflation is a result of shortages in essentials, the Finance Ministry, along with the RBI, continues to believe it is due to excess demand-induced factors. So far North Block had left the battle to the RBI; now it has joined the fight if the latest directive on External Commercial Borrowings (ECBs) is any indication.

Last weekend, North Block banned ECBs for a section of the real-estate sector. ECB had not been permitted for the real-estate sector but an exemption was made for integrated townships of 100 acres and above. The Finance Ministry directive now does away with that exemption thus effectively barring the external debt route for the real-estate sector altogether. North Block has also lowered the interest rate caps on ECBs of differing maturities by companies using the automatic or approval route. Both modifications are to curtail the inflow of capital and, as a result, the external debt of the country. On this score the moves, in general, may be justified. According to the data for the quarter ending December 2006, ECBs witnessed the largest growth of 11 per cent, taking their share in the country's total external debt to 25 per cent, second only to NRI deposits (26 per cent).

While foreign currency assets are comfortable, some brake on the debt pile-up is welcome. But on other grounds the Finance Ministry's actions appear shortsighted. The real-estate sector has not been favoured by the RBI yet it has become the hottest growth area for global investors and chances are that funds will find a way of getting in and not necessarily through equity alone. Second, lowering the interest rate caps on ECBs disadvantages smaller but ambitious companies that may be willing to carry a costlier foreign debt so long as it is cheaper than domestic loans. With bank credit getting dearer at home, small and efficient companies will feel taxed doubly by the new ceilings. This is an unwelcome trend for the future of a competitive economy that must enable a dynamic evolution of firms at all times for inclusive growth.

It is not clear that restricting the volume of ECBs will necessarily contain the debt build-up though it may reduce foreign investments into the real-estate sector for a while. The economy has built itself a name and policies to curb inflows could send the wrong signals to the global investor. That would be far too heavy a price for policies aimed at curbing inflation by reducing liquidity in the system.

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