External commercial borrowing/Understanding foreign debts

Fund or loans borrowed from outside world or non-resident lenders by corporates, commercial banks or governments is known as external commercial borrowing.

Country with current account deficit needs capital account surplus to balance current account deficit. Capital account surplus implies that the country is debitor to the outside world. It means that foreigners have more claims in domestic assets than liabilities.

In India, apart from portfolio investment, external commercial borrowing is an important means to raise funds. And, it is part of capital account in the balance of payments.

What is mean by external commercial borrowing

Especially, in India, when corporates, commercial banks, and even government need loans for different purposes, they borrow from international non-resident lenders in the form of foreign currency. Foreign or non-resident lenders includes commercial banks, governments, international financial institutions etc.

In India, Reserve Bank of India by the means of external commercial borrowing framework facilitates domestic borrowers like corporates, banks, governments to avail money in the foreign currency.

But, loan raised by the external commercial borrowing has minimum average maturity compare to long term loans. It is highly essential for a nation who wants to promote doing business ease and attract foreign direct investment in country.

Notably, these loans and interests obliged to pay in the same currency in which loan is availed by the borrower from lender.

Nature of external commercial borrowing in India

In India, there are two routes of approval. One is automated routes and other approval. There is also a cap on the borrowing for a certain sectors. But, 50 percent above is permitted and even for certain sectors it is upto 75 percent.

Importantly, external commercial borrowing is highly preferred as it is low interest loans than domestic loans.

Advantages of external commercial borrowing

Obviously, ECB is the best gateway for most of the needy to borrow funds from non-resident lenders instead to overlay depends on the costly domestic.

Low interest rates and avarage maturity make it more attractive choice for financially parched corporates and banks.

Besides, loans in foreign currency is more beneficial as it helps to facilitate players to imports they need most from international market.

Disadvantages of the external commercial borrowing

Actually, if the loan is available easily with lower interest rates and avarage maturity by non-resident lenders, it may cause higher debt on the balance sheet of borrower.

And, eventually, chances of downgrade of the company in question can’t be denied by the credit rating institutions. In this way, ECB may cause adverse effects on the market value of companies.

Further, as I explained before that the borrower is obliged to pay the principal and interest in the same currency in which it is received. Therefore, exchange rate will be a cause of concern for the borrowers at the time of maturity.

Last words on external commercial borrowing,

Finally, not all the players are in position to avail the borrowing as it is determined by the multiple rules and regulations.

Nevertheless, in the age of open economies, it is the best means to raise funds with lesser interest and avarage maturity time for those who either want to expand or start new business journey.

Solved questions on external commercial borrowing,

Here are some useful solved questions on topic to get better insight.

Q. Who are non-resident lenders?

Ans: Those foreign Investors who wants to invest or lends money hoping to get better return. In India, corporates, commercial banks and governments borrow funds from non-resident lenders like international financial institutions, commercial banks, and governments can lends money.