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Introduction to foreign loans

Loans from foreign institutions (for those enterprises that are eligible to take them) are called ‘external commercial borrowings’ or ECBs. ECB is an important source of growth capital for most of corporate India, especially strategically important sectors such as power, aviation and infrastructure. This is so important for Indian business eco-system that almost every law firm has an entire team dedicated to ECB related matters. ECB is arguably the cheapest source of capital available in India, although not everyone is allowed to access this source.

The loan could be taken from a foreign bank – e.g. Standard Chartered London, HSBC Hong Kong or HSBC Munich, or a foreign financial institution such as Asian Development Bank and so on. However, a loan from Standard Chartered in Mumbai or HSBC in Delhi will not qualify as an ECB, because such loan will be provided in rupees. ECB is a loan taken in foreign currency. Note that the term ECB also covers bonds, preference shares and debentures (i.e. both non-convertible and optionally convertible debentures and preference shares) issued to foreigners apart from simple loans. A loan taken from a foreign shareholder who owns at least 25 percent of the shares of the borrower company is also included within the ambit of ECBs.

  NOTE: Convertible debt is a type of debt which the holder can convert into shares of the issuing company. Convertible debt instruments are hybrid securities with both debt and equity-like features. The holder of such securities can enjoy the security of debt and interest payments while the instrument is a debt, and can convert the same into equity shares to participate in the growth of the company – thereby maximizing benefits. Convertible debt can be either optionally convertible or mandatorily convertible. In India, mandatorily convertible debt is considered to be equity for Foreign Exchange laws and FDI regulations purposes, while all other convertible instruments are considered to be debt and falls under ECB regulations if issued to no-residents.

Why should a business consider taking a loan from a foreign lender? Why not just borrow from Indian lenders or banks?

Benefits of a foreign loans


In India, interest rates, which are controlled by the RBI, have been quite high when compared to the rest of the world. At present, USA has an interest rest close to zero whereas Indian banks lend money for commercial purposes above 12% at least (interest rates can easily go upto 18% and The difference is quite significant – the US prime rate is 3.25 percent, while the base rate on the RBI’s website is 9.55 – 10.5 percent, as of 1 November 2011,  See RBI website and Fed Prime Rate website) Thus, ECB is attractive for Indian businesses as they can avail of loans from many other countries which have lower interest rates. This enables them to borrow money very cheaply (for instance, it could be 5-6% depending on global standards).

However, not all categories of businesses are eligible to take foreign loans. If ECBs were allowed to be taken freely, it could pose a foreign exchange problem (since money borrowed in foreign currency is paid back in foreign currency as well) and Indian banks will collapse as no one will borrow money from them at the high rates they charge.

Hence, the Reserve Bank of India (RBI), which lays down the regulatory policy for ECBs, allows ECBs to be obtained only in a limited number of circumstances.
All other requirements of loan financing or borrowing must be met from Indian lenders. Some entities are only required to comply with procedural requirements while availing of ECBs. They do not require approval of RBI. This mechanism is called the ‘automatic route’. In other cases approval of RBI is required. Also, note that ECB can be taken only for certain kind of purposes, and there are many limitations on how the borrowed money can be spent.

There are strict regulations with respect to what should be the maturity period and how much interest can be paid. Anyone interested in taking ECB has to know and comply with all these rules.
 These limitations are mentioned in in the Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000 (ECB Regulations) (discussed below).


NOTE: The various regulations and notifications related to ECB are annually consolidated into a Master Circular on External Commercial Borrowings issued by RBI on July 1 (available on the link), which can be used for reference.

To begin, it is essential to know the purposes for which such loans can be utilized and which entities can take foreign loans.

Source of law and regulatory policy


B. What are the purposes for which foreign loans can be utilized?

An ECB can only be utilized for specific purposes, as below:

(i) in making investments such as by way of import of capital goods;(Here the definition of capital goods is as specified by the Directorate General of Foreign Trade in the Foreign Trade Policy).

(ii) implementation of new projects or modernization and expansion of existing production units in the Indian "real" sector (i.e. the Indian industrial sector, not real estate as sometimes mistaken), the Indian infrastructure sector and specified service sector, namely hotel, hospital, software in India.

An ECB cannot be taken for:

(i) Lending further from the ECB proceeds, investment in capital markets, or acquiring a company in India by a corporate investment in special purpose vehicles, money market mutual funds, etc.

(ii) Real estate sector, acquisition of land

(iii) Working capital, general corporate purpose and repayment of existing rupee loans.

ExceptionIn certain cases, ECB can be taken by a borrower which is operating in the infrastructure sector to repay a rupee loan taken from a domestic bank.

An Indian borrower may require a foreign loan for making payments abroad (i.e. in foreign currency). In such situations ECB proceeds which are intended for foreign currency expenditure can directly be retained offshore by the borrower. The balance portion (meant for rupee expenditure in India), such as purchase of capital goods from the Indian market, etc. must be brought into India immediately and credited with the borrowers' rupee account with an authorised dealer Category I bank in India. Rupee funds are not permitted to be used for inter-corporate lending.

C. Which entities can avail of foreign loans?

Which entities can obtain foreign loans?


An ECB can only be taken for an end-use explained above. Only entities which are operating in the real/ industrial sector (that is, which are involved in the manufacture of products) and service sector companies in the hotels, hospitals or software sector can avail of ECBs.

In order to be able to take an ECB, the borrower should be structured as a company. Sole proprietorship businesses, partnership firms, LLPs and non-profit organizations cannot take ECBs. Therefore, if an entrepreneur considers taking foreign loans for his business (say for example, if the business is capital intensive), he should consider structuring the venture as a company if he intends to avail of foreign loans


ECBs can be taken from the following entities:

  • International banks, multilateral financial institutions (such as Asian Development Bank, International Finance Corporation, etc.),
  • International capital markets – by issuing bonds or debentures to foreigners and listing them on a foreign exchange such as the London Stock Exchange
  • export credit agencies, equipment suppliers,
  • foreign collaborators and foreign equity holders (subject to conditions mentioned below).

D. Process for availing ECBs

can be accessed either under the automatic route (which does not require prior regulatory approval) or through the prior regulatory approval of the RBI. Under the automatic route, borrowers are required to submit Form 83 to the designated Authorized Dealer Bank to obtain a Loan Registration Number (LRN) (certified by a company secretary or chartered accountant). The AD Bank forwards a copy of Form 83 to the Department of Statistics and Information Management of RBI. Any money towards the loan can only be borrowed after allotment of the LRN (even though loan agreement can be executed before).


NoteThe loan agreement is not required to be submitted.

Under Approval Route, the borrower submits an application to RBI through an authorized dealer (AD) bank as specified by RBI.

A business which has availed an ECB is required to submit a monthly compliance form called ECB-2 within 7 days before the close of the month to the RBI. The form should be certified by a designated authorized dealer bank which can deal in foreign exchange. Most of well-known private and public sector banks in India can act as authorised dealers.

It is the responsibility of the borrower to utilise the fund obtained under External Commercial Borrowing in accordance with ECB guidelines and RBI regulations. The designated Authorised Dealer bank is also required to ensure that raising and utilization of ECB is in compliance with ECB guidelines at the time of certification.

E. Terms of the loan - all-in-cost ceilings

Interest rates and Term


The cost of an ECB (which includes not only the interest charged by the bank but also other fees and expenses paid in foreign exchange) should be within the limits mentioned in the table below. The limit is measured with respect to a reference rate called the ‘London Interbank Offered Rate’ or LIBOR - this is the rate that banks in London borrow from each other in the short term to meet their funding requirements (for periods ranging between overnight to even 1 year).

Average Maturity of the ECB

Interest Ceiling

3-5 years

350 basis points (or +3.5%) over the six month London Interest Bank Offer Rate (LIBOR) (or other appropriate reference rate)

Above 5 years

500 basis points (or +5%) over six month LIBOR (or other appropriate reference rate)


1) 1 percentage unit is divided into 100 basis points. Therefore, 1 basis point is 0.01 percent.

2) Commitment fee, prepayment fee, fees payable in Indian rupees and withholding tax are excluded from the cap on costs.
The rate of penal interest should not be more than 2 per cent of the all-in-cost of ECB.

F. Approval and automatic route

ECBs may be available either under automatic route, i.e. without any regulatory approval or by taking approval of the RBI. In general, most companies can borrow under the automatic route. 

Approval Route

Approval is required only under the following cases:
  1. A service sector company that is not in hotels, hospitality or software services avails of an ECB. For example, training institutions, R&D service companies and other service companies will require approval of RBI to take an ECB. Further, these entities can only take ECB from a foreign shareholder who owns at least 25 percent shares.
  2. Co-operative societies, financial institutions/ banks and SEZ developers (for providing infrastructure facilities in an SEZ) take an ECB.
  3. If the terms of the ECB exceed the limits provided in the table below.

Limits above which approval is required

If the ECB amount is in excess of following limits

For hotels, hospitals or software

USD 200 million in one financial year

For other real-industrial sectors

USD 750 million in one financial year.

If the maturity period is in excess of the following{C}[1]

For ECBs up to USD 20 million in a financial year

3 years

For ECBs between USD 20 million - 750 million

5 years


  1. Banks, financial institutions and infrastructure finance companies can only take ECBs under approval route.
  2. The option to raise an ECB from a foreign equity holder is impractical for most early stage service sector businesses (which are not in hotels, hospitals or software). It is extremely unlikely for a service sector business to have a foreign equity holder in the first place (a foreign equity holder is basically a foreign shareholder holding at least 25 percent of the shares of the company, as per the ECB Regulations). Many businesses do not raise investment from foreigners in their first funding round, but in subsequent rounds.
  3. It is not common for a foreign financial investor to take a stake above 25 percent. Many foreign investors take a much smaller stake.
  4. The requirement to obtain an RBI approval after eventually having complied with the above conditions also makes the process uncertain and cumbersome.
Therefore, service sector companies which are not under the software, hospitals or hotel industry will find it extremely difficult to obtain ECB.

Questions for self-assessment: 

  1. There is a software company in Kochi developing Productivity Softwares for clients who are mostly outside India. It has no foreign shareholder. Can it obtain ECB?
  2. What if it was a BPO company instead of a software company?

G. Conversion into equity

When a company is unable to repay its loans, it can restructure its debt by converting some or all of it into equity (with the lender’s consent). Conversion of debt into equity eliminates the obligation of the company to repay debt (to the extent that it has been converted). In this regard, if a company is contemplating conversion of ECB into equity – it must ensure that shares are issued in accordance with pricing guidelines under FEMA and that the equity holding of the ECB lender after conversion is within the sectoral cap.


H. Consequence of violation of ECB Regulations

Violation of the provisions of the regulations will attract the penalty provisions under
Section 15 of FEMA. Violation of the provisions of the ECB regulations is punishable with a penalty of up to thrice the amount involved (or INR 2 lakhs if the amount is not quantifiable). In addition, corporates who have violated the ECB policy and are under investigation by RBI can only avail ECB under the approval route. Where the violation is a continuing one, an additional penalty of INR 5000 per day is payable.


I. Options for a borrower in case of violation

Sometimes, violations may be unintended. In such cases, it may be advisable to rectify them when they are discovered by compounding with the RBI, which may help in a much lower penalty being payable. Compounding under FEMA is similar to a settlement, except that the entity on the other side is not a private entity, but a regulator, i.e. RBI. Compounding proceedings can take up to 6 months to be completed.

[1] Note: RBI computes uses an expression called the ‘minimum average maturity period’ which is usually calculated by financial institutions on the basis of a mathematical formula.

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