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May
22, 2007
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withdrawn the exemption accorded to the “development of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:
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