Problems with the RBI’s new ECB framework

guest post is by Pratik Datta and Shefali Malhotra, who are Consultants
at the National Institute of Public Finance and Policy (NIPFP). They can be
reached at
[email protected] and [email protected]

This blog had earlier
explained the policy backdrop leading up to the Reserve Bank of India’s (RBI’s)
draft framework for External Commercial Borrowing (ECB). Recently, the RBI
released two circulars and one amending regulation in its effort to “liberalise
the ECB regime:
(DIR Series) Circular No. 17
dated September 29, 2015: Provides a framework
for the issuance of Rupee denominated bonds overseas
(DIR Series) Circular No. 32
dated November 30, 2015: Provides a revised
framework for the ECB Policy, comprising medium term foreign currency
denominated ECB with minimum average maturity (MAM) of 3-5 years, long term
foreign currency denominated ECB with MAM of 10 years and Indian Rupee
denominated ECB with MAM of 3-5 years.
dated December 2, 2015: Amends the Foreign Exchange
Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000
allowing the RBI, in consultation with the Central Government, to prescribe
certain changes to the regulations for foreign exchange (FX) and Indian rupee (INR)
borrowing under approval and automatic routes.
In this post, we show the policy inconsistencies and
drafting errors across these circulars and regulation.

revisiting the policy backdrop
The current ECB reforms are based on a detailed
of the Sahoo Committee. The Committee argued that the purpose of any
financial regulation is to address market failure. With regards to ECB, the
only potential market failure arises from currency exposure. This nudged the
policy-makers to rethink the policy behind INR denominated borrowings, where
the currency risk is completely borne by the lender thereby alleviating the
systemic risk concerns on the Indian borrowers’ side. Therefore, from a policy
perspective, there is no difference between INR denominated bonds and INR
denominated borrowings that justifies different regulations for these.

differentiates INR bonds from INR borrowings
The RBI has issued two circulars: One is on INR bonds
(Circular 17) and the other is on INR borrowings (Track III of Circular 32).[1]
The framework for the issuance of INR bonds and INR borrowings provides
different conditions for eligible borrowers, recognised investors, end use
restrictions, etc. The framework for issuance of INR borrowings is more
restrictive than for INR bonds.
For example, while any investor from FATF[2]
jurisdiction can invest in INR bonds, only nine investor classes are recognised
for investment in INR borrowings. Similarly, there is no end use restriction
(except a negative list) in the case of INR bonds. On the other hand, the
framework for INR borrowings provides a list of permitted end use for different
As suggested by the Sahoo Committee, the objective of
regulating ECBs is to address the potential market failure that can arise from
currency exposure alone. In the case of INR bonds as well as INR borrowings,
there is no currency exposure. Hence, the reason for the variance between these
two frameworks is unclear and does not stem from the recommendations of the
Sahoo Committee. Unfortunately, unlike SEBI, the RBI has not yet voluntarily
started issuing discussion papers regularly before making regulations as is
required under the FSLRC Handbook.
This makes it even more difficult to discern what regulatory concern could have
prompted the RBI to digress from Sahoo Committee’s recommendations.


Can the
RBI regulate trade credit or short term credit facilities for working capital?
Post liberalisation, India decided to comply with Art. VIII of the IMF
Articles of Agreement
. Consequently, one of the crucial policy reforms introduced
in the Foreign Exchange Management Act (FEMA) in 1999 was full current account
convertibility through statute. Full capital account convertibility could not
be enshrined in the statute since in the aftermath of the East Asian
crisis of 1997
there were scepticisms about the idea. Accordingly, section
5 of FEMA provides for full current account convertibility by default except to
the extent that the Central Government may impose restrictions through rules.
On the other hand, section 6 of FEMA provides restricted capital account
convertibility and the RBI was given wide powers to regulate such transactions.
This arrangement was agreed upon since it enables opening up of capital account
through regulations in the future without having to amend the statute itself.
With this legislative intent, section 2(j) of FEMA
defines `current account transaction’ to include payments due in connection
foreign trade, other current business,
services, and
short-term banking and credit facilities
in the ordinary course of business
. Essentially, it means that trade
credits as well as short term foreign currency borrowings for working capital
are current account transactions. Since these are not capital account
transactions, the RBI does not have jurisdiction to regulate them in the first
place. Instead, it is the Central Government which has power to issue rules on
these transactions. However, in practice, Central Government does not regulate
them — instead the RBI has been regulating
trade credit and ECB for working capital under the FEMA (Borrowing or Lending
in Foreign Exchange) Regulations, 2000 as if these were capital account
transactions. The new ECB framework continues with the same mistakes,
contradicting the basic policy behind FEMA — full current account


(criminal) action for violating ECB guidelines?
Circular No. 32 states that:
The primary responsibility for
ensuring that the ECB is in compliance with the applicable guidelines is that
of the borrower concerned. Any contravention of the applicable provisions of
ECB guidelines will invite penal action under the Foreign
Exchange Management Act 1999 (FEMA).
If `penal action’ is intended to mean `criminal
action’, then this statement is legally incorrect with respect to Track III INR
One of the primary policy objectives of the FEMA was
to move away from the philosophy of the Foreign Exchange Regulation Act, 1973
(FERA) of criminalising contraventions of foreign exchange regulations.
Accordingly, FEMA was originally a civil statute and did not impose any
criminal sanction for any contravention. However, in a political effort to
pacify black money related grievances, the Finance Act,
, for the first time introduced criminal provisions under FEMA, with
the objective of addressing the menace of black money. From September
9, 2015
, section 13 of FEMA stood amended. Therefore, as of now, section
13(1C) read with sections 37A and 4 of FEMA criminalises acquisition of foreign
exchange, foreign security or immovable property, situated outside India, in
violation of FEMA.
It is important to note that in case of INR borrowings
or INR bonds, the borrower is not acquiring any foreign exchange. Therefore,
this criminal provision under the current FEMA does not extend to any such
borrower. To this extent, the usage of the words penal in Circular No.
32 is incorrect.


superfluous amendment or institutionalising ad hocism?
The Foreign
Exchange Management (Borrowing or Lending in Foreign Exchange) (Amendment)
Regulations, 2015
adds Paragraph 4 in Schedule 1 of the Foreign Exchange
Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000, which
that under these Regulations, the Reserve Bank may, in consultation with the
Government of India,
prescribe for the automatic route,
any provision or proviso regarding various parameters listed in paragraphs 1 to
3 above of this Schedule or any other parameter as prescribed by the Reserve
Bank and also prescribe the date from which any or all of the existing proviso
will cease to exist, in respect of borrowings from overseas, whether in foreign
currency or Indian Rupees, such as addition / deletion of borrowers eligible to
raise such borrowings, overseas lenders / investors, purposes of such
borrowings, change in amount, maturity and all-in-cost, norms regarding
security, pre-payment, parking of ECB proceeds, reporting and drawal of loan,
refinancing, debt servicing, etc.
Section 2(x) of FEMA 1999 states that `prescribed’
means prescribed by rules made under this Act, while 2(zd) states that
`specify’ means to specify by regulations made under this Act and the
expression “specified” shall be construed accordingly. The statute
empowers the RBI to issue regulations (section 47) while the Central Government
is empowered to issue rules (section 46). The RBI is not empowered to
`prescribe’ rules, but can only `specify’ regulations. Therefore, the amending
regulation has wrongly used the word `prescribe’ instead of `specify’. This
drafting error although seemingly innocuous needs to be treated with caution
since section 139 (yet to be notified) of the Finance Act, 2015, has shifted
some of the RBI’s regulation making powers within the Central Government’s rule
making zone.
It seems that this amendment was intended to empower the
RBI, in consultation with the Central Government, to insert or remove
provisions in the Schedules. But the RBI always had this power under section
47. It could always have amended its own regulation to insert or delete
provisions or provisos therein. So what was the need for this additional
provision? Is it merely superfluous?
It is hard to imagine that an entire amendment to a
FEMA regulation would be completely superfluous. In that case, the only
explanation could be that the RBI intends to use this provision to exempt the
application of some provisions or impose certain additional obligations on
transactions under these regulations on a case-to-case basis after consultation
with the Central Government. This may have been necessitated due to the Tata-Docomo
debacle where the RBI had initially intended to exempt the Japanese investors
from the application of the pricing norms but was then reportedly
instructed by the Central Government to follow its own rules and not exempt
transactions on a case to case basis. If this is indeed the intention behind
this amendment, it would institutionalise regulatory ad hocism — the
antithesis of rule of law.

Any major policy shift is bound to have implementation
issues. However, administrative convenience should not be an excuse for
diluting the policy intent. The RBI’s new initiative to revamp the ECB
framework is indeed a welcome step. However, there still remains much (watch M.S.
Sahoo’s interview
and read Mukesh
Butani’s piece
) to expect from the Central Bank.
– Pratik Datta & Shefali Malhotra

[1] There is some
confusion on this issue. However, Clause 6(iii) of the Annex of Circular 32 at
page 8 of 16 states: These limits are separate from the limits allowed
under the framework for issuance of Rupee denominated bonds overseas.

Clause 6(i) applies to all the three tracks including INR borrowings in Track
III. Therefore, it is submitted that the circular treats INR borrowings and INR
bonds differently.
[2] Financial Action Task Force.
[3] Penal action need
not necessarily mean criminal action. See Ritesh Agarwal v. SEBI, (2008) 8 SCC
[4] A similarly
worded paragraph 6 has been inserted in Schedule II for approval route.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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