Foreign Currency Loans from Financial Institutions and Banks

           

 

I.   FOREIGN CURRENCY LOANS FROM FINANCIAL INSTITUTIONS

 

In the case of large projects involving heavy capital equipments, foreign currency loans are emerging as an important source of project finance. The Department of Economic Affairs, Government of India, specifically permits borrowings in foreign currencies in respect of specific projects. While submitting the application to the committee approving capital goods imports, the entrepreneur is required to specifically mention foreign currency loans a, source of finance. It is therefore, important that the foreign currency loans source of project finance are identified well in time.

 

While identifying the foreign currency loans as a possible source of project finance, the entrepreneur should take into account : (a) the options available the international market; and (b) the cost effective financing alternatives a foreign currency exposure management.

 

There are two types of external sources available for raising foreign currency borrowings:

 

(i) funds that can be raised on fixed rates of interest (i.e. fixed  borrowings); and.

(ii) funds that can be raised on floating rates of interest (i.e. floating-rate borrowings).

 

Fixed-rate borrowings insulate the borrower against movements in the interest rates. Floating-rate borrowings, on the other hand, enable the borrow to take advantage of downward movements in the interest rates.

 

Fixed-rate Borrowings

 

The most commonly used methods of raising fixed-rate funds for financing capital goods imports are : (a) Buyer's credit; (b) Supplier's credit and (c) Fixed-rate loans.

 

(a) Buyer's credit

 

Under a buyer's credit arrangement, a specific long-term loan is granted by a designated lending agency in the exporter's country to the buyer in the import, country against a guarantee by an acceptable bank or financial institution. The supplier receives payment for the exports on his delivering to the lending agency the requisite documents specified in the loan agreement and the relative commercial contract. The lending agency realises the payment from the buy (importer) in instalments as and when they fall due. Ordinarily, the supplier of his obligation reckons the period credit as the duration from the date of completion

.

(b) Supplier's credit

 

Suppliers credit, on the other hand, is extended to the supplier (exporter) by the financial institutions (in the exporter-country) to finance his deferred receivables. The buyer is required to provide the requisite guarantee from an acceptable bank or financial institution in the importer country.

 

Credit may also be extended by the supplier (exporter) directly to his buyer (importer) on the deferred payment terms against his providing a guarantee as above. In this case, the supplier will realise the proceeds of his exports by discounting the bills of exchange (drawn on and accepted by the buyer) with his banker or the designated Government agency in his country. Such credits however, are not really supplier's credit in the technical sense. These are in the nature of trade credit.

 

Technically both supplier's credit and buyer's credit are extended by the lending agency in the exporter's country; when it is granted to the supplier (exporter), it is a supplier's credit; and when it is granted to the buyer (importer) it is a buyer's credit.

 

(c) Fixed-rate loans

 

In addition to the above two methods, fixed-rate loans can also be raise through commercial banks. Such loans are normally arranged for a period upto 8 years and are priced at a specific spread above the going rate in the concerned country of the chosen currency.

 

Comparative Cost Advantage

 

Of the above three types of credit, supplier's credit may, in many cases, prove to be more expensive as the supplier is likely to add a premium in the price quoted for the goods or in the rate of interest so as to compensate him for the additional cost incurred by him in the process. As against this buyer's credit may be relatively cheaper as the supplier under this arrangement is paid off immediately and the lender realises die payment from the buyer as per agreed terms. The interest rate quoted on the fixed-rate loans by the commercial banks will depend upon the competitive edge of the concerned bank in the particular Euro-currency market

 

Methods of Raising Foreign Currency Loans

 

There are two methods of raising foreign currency loans; (i) through Financial Institutions under Lines of credit & (ii) directly from abroad. In this Chapter we shall discuss foreign currency loans through financial institution only. Raising foreign currency loans abroad directly i.e. external commercial borrowings will be discussed in the next Chapter.

 

Lines of Credit

 

The all India financial institutions have arranged various lines of credit in different foreign currencies from various international development agencies and banks including World Bank and foreign currency loans are sanctioned as apart of project finance out of these lines of credit. The salient features of foreign currency loans sanctioned by all India financial institution are as under:

 

§         The rates of interest on foreign currency loans are either fixed or floating depending upon the terms and conditions applicable on the line of credit out of which a particular foreign currency loan is sanctioned.

§         Other terms and conditions including repayment period are also dependent on the original line of credit and entire repayment has to be within the terminal date of original credit to the financial institution.

§         All foreign currency loan attract a uniform up front fee of 1 %p.a. from the date of issuance of letter of intent by the financial institution.

§         Convertibility clause is not applicable in case of foreign currency loans.

 

The various steps involved for availing of foreign currency loan are as follows:

 

q       The lending institution will issue letter of intent for foreign currency loans.

q       Take steps to get capital goods clearance from Secretariat of Industrial Assistance and for obtaining import licence from the Director General of Foreign Trade, where applicable.

q       Convene Board meeting to accept the letters of intent issued by the lending institution and convey acceptance to the institution by sending copy of Board Resolution passed in this regard.

q       Obtain copy of foreign loan agreement and guarantee agreement etc. as required in terms of sanction from the lending institution and arrange proper execution of same by authorised persons to the satisfaction of the institution.

q       Obtain necessary application forms for issuance of import letters of credit.

q       Payment in respect of imported machinery will be directly made by the institutions to the overseas suppliers against letters of credit opened by them by disbursing the loan.

 

Efforts are, however, being made to rationalise the procedure and bring uniformity by adopting a common approach to foreign currency loans and a beginning in this regard has already been made. Full details of the procedure are given in the later part of this chapter.

SELECTION OF FOREIGN CURRENCY

 

Foreign currency loans availed from financial institutions are repayable in Foreign currency itself and the borrower in such cases is exposed to exchange fluctuation risks. Selection of foreign currency thus gains importance. Long-term prospects as regard to stability in the value of foreign currency vis-a-vis the interest rates applicable on the loan must be analysed before selecting the foreign currency.

 

Another important factor in this regard which needs careful examination the currency of loan and currency of payment at the time of import of machinery etc. i.e. against a loan in US $, the payment of the foreign supplier of machinery can be made in Japanese Yen. This is a very difficult situation for the importer as total rupee outlay will not only be effected by a change in exchange rates of dollar vis-a-vis Indian rupees but will also be effected by a change in Japanese Yen-US $ rate. For example, if Japanese Yen appreciates by about 30% a US $, the liability in US $ will increase by 30% without any corresponding increase in Japanese Yen liability.

 

Import of capital goods may generally involve a long time and letters credit are opened with relatively longer commitment period and change in rate between the currency of invoicing and currency of loan may play a with the financial planning of a project. In situations as quoted in the example, the very successful completion of the project may be endangered  to extra load of 30% required to meet the import commitment. It is, therefore absolutely necessary to foresee such situations. The ideal solution to the above problem is to ensure that the currency of invoice and currency of loan are or the same.

EXCHANGE RISK

 

From the discussions in the preceding paragraphs we can identify following risks for the promoter while availing foreign currency loans.

 

q       Fluctuation in the parity rate between the currency of invoicing currency of loan,

(The risk is carried from the date of purchase contract of machine the date of settlement of payment.)

q       Exchange rate fluctuation in the currency of loan in term  of Indian rupees.

(The risk is carried from the date of availing of loan till the instalment is repaid on reducing scale.)

 

How to Cover the Foreign Exchange Risk?

 

Covering the foreign exchange risk is termed as hedging the risk. company does not want to hedge, it means it is taking a view that the future movements of exchange rates will move in its favour. If the company adopts policy of hedging everything, and the spot rates move in favour of the company, the company will lose out or incur the opportunity cost by hedging the exposure if the rates move against.

 

There may be partial hedging where a view is taken that only those exposures where it is anticipated that risk of losses could exceed the opportunity to gain need to be hedged. However, it is prudent going by the past experience to fix a limit which could be left unhedged. While the cost of hedging is quite relevant in the context, the risk factor might take a heavy toll and hence basically it is undeniable that exchange risks have to be hedged in the current scenario.

 

There are many techniques provided by banks and financial institutions which offer hedges in many forms as under

 

(i) Forward Contracts

This is a usual hedge extended to customers. Banks offer forward exchange contracts both for sale and purchase transactions to customers with a maturity date for a fixed amount at a determined rate of exchange at the outset. Normally contracts are entered in India for a period where the maturity period of the hedge does not exceed the maturity of the underlying transaction. The customer has the option to choose the currency of the tenor.

 

Roll Over Forward Exchange Contracts

 

Roll over forward contract is one where forward exchange contract is initially booked for the total amount of loan etc. to be re-paid. As and when instalment falls due, the same is paid by the customer in foreign currency at the exchange rate fixed in forward exchange contract. The balance amount of the contract is rolled over (extended) till the due date for the next instalment. The process of extension continues till loan amount has been re-paid. But the extension is available subject to the cost being paid by the customer, thus under the mechanism of roll over contract the exchange rate protection is provided for the entire period of the contract and the customer has to bear the roll overcharges, if any. The cost of extension (roll over) is dependent upon the forward differentials prevailing on the date of extension. Thus, the customer effectively protects himself against the adverse spot exchange rates but he takes a risk on the forward differentials (i.e. premium/discount). Although spot exchange rates and forward differentials are prone to fluctuations, yet the spot exchange rates being more volatile, the customer gets protection against the adverse movement of exchange rates.

 

We can appreciate that there is not much difference between rolling over of the forward exchange contract and extension of forward exchange contract, except that in the case of former the exchange contract is extended for the balance amount left after the instalment has been remitted while in the case of latter the exchange contract for the entire amount is extended. The cash inflows and outflows are quite large and so also interest on the same. Therefore, sometimes if the foreign currency appreciates continuously the extension of forward sale contract turns out to be a costly affair.

 

As per exchange control regulations, the forward contracts can be rolled over for periods less than six months also. The interest, as in the case of extension, on inflows has to be paid to the customer. Similarly, on cash outflows bank is entitled to recover, interest.

 

(ii) Currency Futures

A future contract is an agreement to buy or sell a standard quantity of specific financial instrument at a future date and at an agreed price. A corporate can take up a future contract which is opposite to his foreign currency transaction exposure. However, the futures are reviewed on a daily basis based on spot rate Therefore, the values of the futures contract varies depending on the agreed price. Hence, the resultant spot rate will determine the loss or gain on the transaction exposure and can be counteracted by the resultant loss or gain, on futures contract.

 

(iii) Currency Option

Currency option gives the right but no obligation to the buyer of the option to sell (put option) or buy (call option) a specific amount of foreign currency a pre-determined price called strike price. There are tailor-made options which can be picked up over the counters of the banks. The buyer of an option has pay a price-premium for conferring the above right by the option writer i.e. banks.

 

Foreign Currency-Rupee Swaps

 

A swap is a financial transaction in which two counterparts agree exchange streams of payments or cash flows over a period of time with a view to achieving overall cost reduction for both parties.

 

Authorised dealers may arrange foreign currency-rupee swaps between corporates who run exposures arising out of their long-term foreign currency commitments.

 

Hedging of Loan Exposures

 

Authorised dealers can offer hedging products to Indian corporates without the Government's or the Reserve Bank's prior approval. Such approval is a not required to unwind hedge transactions, the authorised dealers having be allowed to remit upfront premia as well as other charges incidental to the hedge transaction without prior approval of the Reserve Bank.

 

According to FEM (Foreign Exchange Derivative Contracts) Regulation 2000, authorised dealers can offer interest rate swaps, currency swaps, coup swaps, foreign currency option, purchase of interest rate caps/collars a forward rate agreements (FRA) to corporates. The products will have to offered by way of booking the transaction overseas or in a back-to-back basis Authorised dealers should ensure, before entertaining the corporate's  request that :

 

(i)                  the contract does not involve rupee,

(ii)        the Reserve Bank has accorded the final approval for borrowing in foreign currency;

(iii)       the notional principal amount of the hedge does not exceed the outstanding amount of the foreign currency loan;

(iv)       the maturity of the hedge does not exceed the remaining life to maturity of the underlying loan; and

(v)                the Board of Directors of the corporate has approved the financial limits and authorised designated officials to conclude the hedge transactions.

 

Interest rate swaps allow companies to move from a fixed interest rate to a floating rate, or vice versa, in the same currency. In a currency swap, when corporates find the ruling interest rate of a particular currency lower than the interest rate of a currency in which they require a loan, they can take a loan in the favourable currency and protect themselves against adverse movements.

 

Coupon Swaps allow moving from fixed interest rate in a particular currency to a floating rate in another currency.

 

With a forward rate agreement, a company can protect itself against adverse interest rate movements. Interest rate swaps do the same but they have to be bought from a bank at a price. For protection on the asset side, the interest rate floor is available to banks.

 

Foreign Currency Option Contract is an agreement wherein the holder has the right to acquire or sell, specified amount of foreign currency; at a specified price (also known as exercise price or strike rate) at which the option can be bought or sold and within the specified time frame (also referred to as expiration date or maturity date).

 

Procedure for Forward Exchange Contracts and Derivative Contracts have been laid down under RBI directions, issued vide AP (DIR Series) Circular No. 19, dt. 24.1.2002 and No. 32, dt. 21.10.2002, consolidated under Master Circular No. 1/2003-04, dt. 1.7.2003, relevant extracts given later.

 

Determinants of Options Value

 

(i)         Spot rate: The effect of this variable on the option price is quite evident. In case of call option, higher the spot rate higher will be the option price (premia) and vice versa. A put option becomes less valuable with the rise in spot price and vice versa.

 

(ii)        Strike price: A call option tends to vary immensely with the strike rate. With the rise in strike rate, the call option tends to lose value. This is because the holder stands to lose when he exercises the call option. A put option moves in direct relation with the strike rate and with the rise in strike rate, the holder tends to gain on exercising the option.

 

(iii)             Time of expiration : With the increase in the time of expiration, both call and put option gain value. This is because the option with larger time to expiration other things being held constant will have higher

 

Caps and Collars

 

Major international banks agree to reimburse to the borrower the cost of LIBOR exceeding a particular level during the currency of the loan. This le is referred to as the 'Cap'.

 

The fee (or insurance premium) to be paid by the borrower would depend upon the difference between the cap and the current rate, the period for which the contract is to run, the anticipated interest volatility, etc. The higher the cap the lower the fee; on the contrary, the longer the period of the contract, the higher will be the fee payable.

 

The cost can be reduced if the borrower simultaneously agrees to a floor the LIBOR. In that case, if the actual LIBOR is less, the difference will have be paid to the insurer. When a contract specifies both the cap and the floor referred to as a 'collar' or a 'band'. This could be considered as the simultaneous purchase of a series of call options and sale of a series of put options on LIBOR. The two strike prices -namely, the cap and the floor , - can be so chosen that the cost of the collar is zero.

 

RBI Regulations on Exchange Risk Management

 

The Reserve Bank has issued Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000, text given in Appendix 10.1

 

RBI Guidelines on Exchange Risk Management* 
 
Forward Contracts

 

A.1 A person resident in India may enter into a forward contract with authorised dealer in India to hedge an exposure to exchange risk in respect transaction for which sale and/or purchase of foreign exchange is permitted under the Act, or rules or regulations or directions or orders made or issued thereunder subject to following terms and conditions

 

(a)                the authorised dealer through verification of documentary evidence satisfied about the genuineness of the underlying exposure, irrespective of the transaction being a current or a capital account transaction Full particulars of contract should be marked on such documents u proper authentication and copies thereof retained for verification. However, authorised dealers may allow importers and exporters book forward contracts on the basis of a declaration of exposure subject to the conditions mentioned in paragraph A.2 of this circular.

(b)                the maturity of the hedge does not exceed the maturity of the underlying transaction,

(c)                the currency of hedge and tenor are left to the choice of the customer,

(d)                where the exact amount of the underlying transaction is not ascertainable the contract is booked on the basis of a reasonable estimate,

(e)                foreign currency loans/bonds will be eligible for hedge only after 1 approval is accorded by the Reserve Bank where such approved, necessary or loan identification number is given by the Regional Office of the Reserve Bank,

(f)                 Global Depository Receipts (GDRs) will be eligible for hedge after issue price has been finalised,

(g)                balances in the Exchange Earner's Foreign Currency(EEFC) accounts sold forward by the account holders shall remain earmarked delivery and such contracts shall not be cancelled. They may, however be rolled-over,

(h)                forward contracts booked in respect of foreign currency exposures residents failing due within one year may be cancelled and rebooked. This facility may be made available only to customers who submit details exposure to authorised dealers in the prescribed format. Forward cont booked to cover exposures falling due beyond one year once cancelled cannot be rebooked. Authorised dealers may continue to offer this facility without any restrictions in respect of export transactions. All for contracts may be rolled over at on-going market rates.

(i)                  Substitution of contracts for hedging trade transactions may be permitted by an authorised dealer on being satisfied with the circumstance, under which such substitution has become necessary.

 

A.2      Authorised dealers may also allow importers and exporters to book for contracts on the basis of a declaration of an exposure and based on performance subject to the following conditions: '

 

(a)        The forward contracts booked in the aggregate should not exceed limits worked out on the basis of the average of the previous financial years' (April to March) actual import/export turnover. This is subject to the condition that at any point of time forward contracts so booked shall not exceed 50% 1 of the limit within a cap of US 100 million.2  These eligible limits are to be computed separately for export and import transactions.

(b)        Any forward contract booked without producing documentary evidence will be marked off against this limit.

(c)        Importers and exporters should furnish a declaration to the authorised dealer regarding amounts booked with other banks under this facility.

(d)        An undertaking may be taken from the customer to produce supporting documentary evidence before the maturity of the forward contract.

(e)        Importers/exporters desirous of availing limits higher than US $ 100 million may forward their applications to the Chief General Manager Reserve Bank of India,  Exchange Control Department, Forex Markets

 

Division, Central Office, Mumbai-400 001 (Fax No. 22611427, e-mail ecdcofmd@rbi.org.in) justifying the need for higher limits. Forward contracts booked under the enhanced limits will be on a deliverable basis. Details of the import/export turnover of the past three years delayed realisations/ payments during these years and existing limits duly authenticated by the authorised dealer, may also be furnished the prescribed format.

 

A.3 A forward contract cancelled with one authorised dealer can be rebooked with another authorised dealer subject to the following conditions:

 

(a)        the switch is warranted by competitive rates on offer, termination banking relationship with the authorised dealer with whom the contract was originally booked, etc.

(b)        the cancellation and rebooking are done simultaneously on the rity date of the contract ,

(c)        the responsibility of ensuring that the original contract has been cancelled rests with the authorised dealer who undertakes rebooking the contract.

 

A.4 Authorised Dealers may also enter into forward contracts with residents respect of transactions denominated in foreign currency but settled in Indian Rupees. These contracts shall be held till maturity and cash settlement would made on the maturity date by cancellation of the contracts. Forward co covering such transactions once cancelled, are not eligible to be rebook

 

Contracts other than Forward Contracts

 

A.5Authorised dealers in India may enter into contracts, other than forward contracts with residents in India in accordance with the following provision

 

(i)         A person resident in India who, has borrowed foreign exchange accordance with the provisions of Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulations, 2000, may enter into an Interest rate swap or Currency swap or Coupon Swap or Foreign Currency option or Interest rate cap or collar (purchases) or Forward Rate Agreement contract with an authorised dealer in India or with a branch outside Indian authorised dealer for hedging his loan exposure and unwinding from such hedges:

 

Provided that

(a)        the contract does not involve the rupee

(b)        final approval has been accorded or loan identification number by the Reserve Bank for borrowing in foreign currency.

(c)        the notional principal amount of the hedge does not exceed outstanding amount of the foreign currency loan.

(d)        The maturity of the hedges does not exceed the unexpired maturity of the underlying loan.

 

(ii)        A person resident in India, who owes a foreign exchange  or rupee liability, may enter into a contract for foreign             currency-rupee swap with  an authorised dealer in India to hedge long term exposure under the following and             conditions:

 

1 .        No swap transactions involving upfront payment of rupees or its equivalent, in any form shall be undertaken.

2.         Swap transactions may be undertaken by banks as intermediaries by matching the requirements of corporate counter-parties

3.         While no limits arc placed on the authorised dealers for undertaking, to facilitate customers to hedge their foreign exchange exposure limits have been put in place for swap transactions facilitating customers to assume a foreign exchange liability, thereby resulting in supply in the market. While matched transactions may be undertaken, a limit of US $ 50 million is placed for net supply in the market on account of these swaps. Positions arising out of cancellation of swaps by customers need reckoned within the cap.

4.         With reference to the specified limits for swap transactions facilitating customers to assume a foreign exchange liability, the limit will be reinstated on account of cancellation/ maturity of the swap and on amortization the amounts amortized.

5.         In the case of swap structures where the premium is inbuilt into the cost, authorised dealers should ensure that such structures do not result increase in risk in any manner. Further, such structures should not result in net receipt  of  premium by the customer.

6.         The above transactions if cancelled, shall not be rebooked or re-entered, by whatever name called.

 

NOTE :

(i)         Authorised dealers should not offer leveraged swap structures clients.

(ii)        Authorised dealers should not allow the swap route to be surrogate for forward contracts for those who do not qualify for  forward cover.

(iii)       A person resident in India may enter into a foreign currency contract with an authorised dealer in India to hedge foreign exchange exposure arising out of his trade :

 

Provided that in respect of cost effective risk reduction strategies like range forwards, ratio-range forwards or any other variable by whatever name called there shall not be any net inflow of premium. These transactions may be freely booked and/or cancelled.

 

Explanation : The contingent foreign exchange exposure arising out of submission of a tender bid in foreign exchange is also eligible for hedging un sub-paragraph.

 

A.6 (i) Authorised dealers should ensure that the Board of Directors of the corporate has drawn up a risk management policy, laid down clear guidelines for concluding the transactions and institutionalised the arrangements for a period cal review of operations and annual audit of transactions to verify compliance with the regulations. The periodical review reports and annual audit report should be obtained from the concerned Corporate by the authorised dealers.

 

(ii) Cross currency options should be written on a fully covered back-to back basis. The cover transaction may be undertaken with a bank outside India, an off-shore banking unit situated in a Special Economic Zone or an internationally recognized option exchange or another authorised dealer in India.

 

(ii)                Authorised dealers desirous of writing options, should obtain one time approval, before undertaking the business, from the Chief General Manager Exchange Control Department, (Forex Markets Division), Reserve Bank of India, Central Office, Mumbai 400 0011 

 

Hedging of commodity price risk in the International Commodity Markets

 

A.7 (i) Residents in India, engaged in import and export trade, may hedge the price risk of all commodities in the international commodity exchanges/market. Applications for commodity hedging may be forwarded to Reserve Bank for consideration through the International Banking Division of an authorise dealer along with its recommendation giving the following details:

 1. A brief description of the hedging strategy proposed; namely:

(a)        Description of business activity and nature of risk

(b)        instruments proposed to be used for hedging

(c)        names of commodity exchanges and brokers through whom risk is proposed to be hedged and credit lines proposed to be availed. The name and address of the regulatory authority in the country concern may also be given

(d)        size/average tenure of exposure and/or total turnover in a year, together  with expected peak positions thereof and the basis of calculation.

 

2. copy of the Risk Management Policy approved by the Management covering;

(a)        risk identification

(b)        risk measurements

(c)        guidelines and procedures to be followed with respect to revaluation and/or monitoring of positions

(d)        names and designations of officials authorised to undertake transactions and limits

 

3. any other relevant information.

A one-time approval will be given by Reserve Bank along with the guidelines for undertaking this activity.

 

Commodity Hedging by entities in Special Economic Zones

 

(ii) General permission has been granted to entities in 'Special Economic Zones' to undertake hedging transactions in the overseas commodity exchanges/markets to hedge their commodity prices on export/import, subject condition that such contract is entered into on a stand-alone basis.1 

 

NOTE: The term "stand alone" means the unit in SEZ is completely isolated  from financial contacts with its parent or subsidiary in the mainland within the SEZs as far as its import/export transactions are concerned.

 

Currency Options and FEDAI Guidelines

 

The salient features of FEDAI Guidelines are as under:

1.         The International Currency Option Market (ICOM) Agreement 28th August, 1992 of British Bankers' Association London with modifications in wording in regard to the applicability of law and  jurisdiction should be used in preparing documentation for currency option contract between the bankers and customers in India.

2.         The banks should obtain request letter from the customer as per specimen provided by FEDAI which inter-alia contains a declaration that there is already no forward exchange cover or foreign option in place against the exposure.

3.         The customers should be required to confirm all transaction banks as per standard ICOM confirmation format. Confirmation be exchanged between the originating bank and the counterpart bank.

4.         The customers should communicate notice of exercise contract two working days in advance before the delivery provided in the ICOM document and such exercise and options should be upto 4 p.m. IST on the date of exercise. Notice of exercise given by facsimile transmission.

5.         Foreign Currency Options can be concluded as per the present regulation only over the counter (OTC).

6.         The bank may write European or American Options (put and call Options only) in respect of customers transactions and cover themselves with the overseas branches/correspondent banks accordingly.

7.         Option premium may be paid and received in foreign exchange. In the case of premiums on options bought by Authorised Dealers charge the premium to the customer by keeping a spread.

8.         The factors that should be reckoned for determining the amount are strike price, maturity period of the contract, currency volatility, interest rate differentials and market condition.

9.         The premium amount once collected is not refundable, not withstanding the fact that the option contract between customer and the bank and/or between the bank and the counterpart bank abroad becomes impossible of performance for what ever reason, including Government prohibitory order.

10.               Option premium may be remitted without the prior approval of Reserve Bank.

11.        Appropriate accounting entries should be passed for options bough and sold and premium amounts received and paid. Option exposure should appear in the accounts as a contingent item.

12.        The accounting procedure should deal with the entire processing cycle. It should necessarily involve the maintenance of the following accounts:

(a)        Contingents (Options purchased/sold);

(b)                  Premium (Receivable/payable accounts);

(c)                  Revaluation Accounts; and

(d)        Profit/Loss Accounts.

13.        Limits should be set for customer exposures; counterpart limits for options purchased should also be laid down.

14.        Options may be bought from overseas and sold to other authorised dealers in India.

15.        Member banks should obtain the revaluation rates from the counterparty banks abroad i.e. the foreign branch of the bank of the overseas correspondent bank with whom authorised dealer has arrangement.

16.        Options written and options purchased should be mailed at suitable periods so as to coincide with the dates on which evaluation of foreign exchange position is done.

 

OBTAINING FOREIGN CURRENCY LOAN FROM IDBI

 

IDBI grants direct foreign currency loans to industrial concerns under its Project Finance Scheme as also under its Equipment Finance Scheme. While the loans under the former Scheme form part of assistance related to projects, loans under the latter scheme are intended for financing import of capital goods and equipment (not related to any specific project/scheme as such) through a simplified procedure. IDBI also considers foreign currency loans under its Corporate Loan Scheme, for meeting capital expenditure and long-term working capital. In respect of units/companies already assisted by IDBI, foreign currency loan may be provided for meeting loan component of working capital finance under assisted by IDBI's Working Capital Loan Scheme. The salient, features of the scheme are spelt out here in after.

 

DIRECT FINANCE SCHEME

Eligibility

 

Any industrial concern which qualifies for IDBI's assistance under statute and envisages import of capital goods for a project is eligible for availing of foreign currency loan from IDBI provided the proposed import is approved by the Import Licensing Authority and allocated to Will or covered under Open General Licence. The project should also satisfy the usual appraisal norms of IDBI. The foreign currency loans are sanctioned on the basis of the requirements of assisted projects and there is no ceiling on the quantum of loans. Foreign currency loans are exempt from the preview of convertibility clause.

 

Sources of Foreign Currency Finance

 

IDBI raises foreign currency borrowings from various sources, such as  Euro market, international institutions, domestic bond markets of foreign countries and export credit agencies. The source to be allocated to a particular foreign currency loan sanctioned by IDBI depends on the country from where the goods are to be imported and the availability of foreign currency funds from a particular source at the time when the borrower desires to open letters of credit

 

Terms and Conditions

 

The terms and conditions of a foreign currency loan depend upon source of foreign currency funds to be allocated to it. Normally, at the time of sanction only a tentative indication is given by IDBI regarding the specific source that may be allocated. Nevertheless, as IDBI would like to utilise its resources, on a first-come-first-served basis, the allocation is normally firmed up to specific line of credit at the time of execution of loan agreement. The term and conditions are finalised at that stage. It is, however, possible that even after the loan agreement is signed and letter of credit is issued, the source of the funds may change. Such situation could arise when there is a large time lag between the time of opening of letter of credit and the payment against shipping documents during which period the particular source of funds could have been exhausted. In case of projects where the amounts of foreign currency loans large, IDBI may like to offer a mix of currencies depending on availability of funds under its credit lines. For this purpose, IDBI reserves the right to change the source of foreign currency financing and alter the terms and condition accordance with such source.

 

Terms and Conditions for Grant of Loans out of Foreign Currency Resources

 

IDBI grants loans in various foreign currencies out of its Euro-Dollar, Japanese Yen, Deutsche Mark, etc. borrowings.

 

Amount of Loan : The loan amount will be normally available up extent of foreign exchange cost (C.I.F. value) of the capital goods/equipment be imported.

 

Rate of Interest: Floating rate based on LIBOR depending upon the source of the currency plus a fixed spread according to the risk perception and maturity of loan.

 

Upfront Fee : Upfront fee will be, levied at the rate of 1% p.a. from the date of Letter of Intent issued by IDBI.

 

Repayment: The repayment period will normally be synchronised with the relative repayment commitments of IDBI in respect of the foreign currency funds utilised for grant of loan. The period of repayment will range upto  10 years (including moratorium) as appropriate lo each case.

 

Security : The loans will be generally secured by a first charge on the assets of the borrowing company including hypothecation of capital goods to be imported.

 

Procedure for Sanctions and Disbursement of Foreign Currency Loans IDBI

 

General: Applications for foreign currency loans should be submitted IDBI's Project Finance Department in Mumbai (or to Regional Offices at New Delhi/Calcutta/Chennai/Guwahati/Mumbai for projects with a total cost up Rs.7 crores) in the prescribed form. The foreign currency loans will be considered on the basis of the usual appraisal norms. The company is thereafter required to execute a Loan Agreement in the prescribed form, for availing of the foreign currency loan.

 

Opening of Letters of Credit.. IDBI opens letters of credit against its c sanctions of foreign currency loans without seeking margin or bank guarantee. After execution of the Loan Agreement, applications for opening of letters of credit in the prescribed form should be submitted to the General Manager, Project Finance Department, Mumbai. The applications should be signed by borrower's officials authorised in this behalf and should be duly supported the following documents:

 

(a)        Resolution authorising the signatories for the purpose;

(b)        Exchange control copy of import licence;

(c)        Purchase order;

(d)        Supplier's confirmation;

(e)        Approval from IDBI on behalf of RBI for Foreign Currency Borrowings from the Exchange Control angle.

 

Currency of Payment.. The risk arising out of exchange fluctuation is to borne by the borrower. All dues will, therefore, be calculated with reference the currency in question and converted into rupees at the exchange rate prevailing on due dates and recovered in equivalent rupees. Thus, up front ,will be calculated on the amount of relevant foreign currency agreed to be made available by IDBI for financing import and the amount of interest and repayment of instalments due will be calculated in terms of currency in which the loan is made and converted into rupees at the exchange rate prevailing on due dates

 

APPENDIX 10.1

Text of Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000* 

               

In exercise of the powers conferred by clause (h) of sub-section (2) of section 47 of the Foreign Exchange Management Act, 1999 (42 of 1999), the Reserve Bank makes the following regulations, to promote orderly development maintenance of foreign exchange market in India, namely,

 

1.Short title and commencement

 

(1) These Regulations may be called the Foreign Exchange Management reign Exchange Derivative Contracts) Regulations, 2000.

(2) They shall come into force on the 1st day of June, 2000.

 

2.Definations.

 

In these Regulations, unless the context requires otherwise,­

 

(i)                  ‘Act' means the Foreign Exchange Management Act, 1999 (42 of 1999);

(ii)                ‘authorised dealer' means a person authorised as authorised dealer under sub-section (1) of section 10 of the Act;

(iii)       'Cash delivery' means delivery of foreign exchange on the day of  transaction;

(iv)       'Forward contract' means a transaction involving delivery, other than Cash or Tom or Spot delivery, of foreign exchange;

(v)        'Foreign exchange derivative contract' means a financial transaction or an arrangement in whatever form and by whatever name, called, whose value is derived from price movement in one or more underlying assets, and includes,

 

(a)        a transaction which involves at least one foreign currency other than currency of Nepal or Bhutan, or

(b)        a transaction which involves at least one interest rate applicable to a foreign currency not being a currency of Nepal or Bhutan, or

(c)        a forward contract,

but does not include foreign exchange transaction for Cash or Tom or Spot deliveries;

(vi)       'Registered Foreign Institutional Investor (FII)' means a foreign institutional investor registered with Securities and Exchange Board of India;

(vii)      'Schedule' means a schedule annexed to these Regulations;

(viii)      'Spot delivery' means delivery of foreign exchange on the second working day after the day of transaction;

(ix)       'Tom delivery' means delivery of foreign exchange on a working day next to the day of transaction;

(x)        the words and expressions used but not defined in these Regulations shall have the same meanings respectively assigned to them in the Act.

3. Prohibition.

 

Save as otherwise provided in these Regulations, no person in India shall enter into a foreign exchange derivative contract without the prior permission of he Reserve Bank.

 

4. Permission to a person resident in India to enter into a Foreign Exchange Derivative contract.

 

A person resident in India may enter into a foreign exchange derivative contract in accordance with provisions contained in Schedule I, to hedge an exposure to risk in respect of a transaction permissible under the Act, or rules or regulations or directions or orders made or issued thereunder.1 

 

5. Permission to a person resident outside India to enter into a Foreign Exchange Derivative contract.

 

A person resident outside India may enter into a foreign exchange derivative contract with a person resident in India in accordance with provisions contained in Schedule II, to hedge an exposure to risk in respect of a transaction permissible under the Act, or rules or regulations or directions or orders made ,or issued thereunder.,

 

6. Commodity hedge.

 

Reserve Bank may, on an application made in accordance with the procedure specified in Schedule Ill, permit subject to such terms and conditions as it may consider necessary, a person resident in India to enter into a contract in a commodity exchange or market outside India to hedge price risk in a commodity.1 

 

2 Provided that a unit in the Special Economic Zone (SEZ) may, without prior approval of the Reserve Bank, enter into a contract in a commodity exchange or market outside India to hedge the price risk in the commodity on export/import, subject to the condition that such contract is entered into on a “stand above” basis.

 

 

Explanation : The term "stand-above" means that the unit in the SEZ is completely isolated from financial contacts with its parent or subsidiary in the mainland or within the SEZ(s) as far as its import/export transactions are concerned.

 

7. Remittance related to a Foreign Exchange Derivative contract.

 

An authorised dealer in India may remit outside India foreign exchange in respect of a transaction, undertaken in accordance with these Regulations, in the following cases, namely

 

(a)       option premium payable by a person resident in India to a person resident outside India;

(b)        remittance by a person resident in India of amount incidental foreign exchange derivative contract entered into in accordance Regulation 4,

(c)        remittance by a person resident outside India of amount incident foreign exchange derivative contract entered into in accordance Regulation 5;

(d)        any other remittance related to a foreign exchange derivative cost approved by Reserve Bank.

 

SCHEDULE I

(See regulation 4)

Foreign exchange derivative contract permissible for a person resident in India1 

 

A. Forward Contract

 

A person resident in India may enter into a forward contract with an authorised dealer in India to hedge an exposure to exchange risk in respect of a transaction for which sale and/or purchase of foreign exchange is permitted under the Act, or rules or regulations or directions or orders made or issued thereunder, subject to following terms and conditions

 

(a)        2 [the authorised dealer through verification of documentary em is satisfied about the genuineness of the underlying exposure otherwise permitted by the Reserve Bank from the time to time

(b)        the maturity of the hedge does not exceed the maturity underlying transaction,

(c)        the currency of hedge and tenor are left to the choice customer,

(d)        where the exact amount of the underlying transaction ascertainable, the contract is booked on the basis of a reasonable estimate,

(e)        foreign currency loans/bonds will be eligible for hedge only after final approval is accorded by the Reserve Bank where such approval is necessary,

(f)        in case of Global Depository Receipts (GDRs) the issue price been finalised,

(g)        balances in the Exchange Earner's Foreign Currency (EEFC) accounts sold forward by the account holders shall remain  marked for delivery and such contracts shall not be cancelled.  They may, however, be rolled-over,

1 [(h)     contracts involving the rupee as one of the currencies, cancelled shall not be re-booked except as otherwise permitted the Reserve Bank from time to time although they can be rolled over at on-going rates on or before maturity. Contracts covering export transactions may be cancelled, re-booked or rolled o on-going rates without any restrictions,]

(i)         substitution of contracts for hedging trade transactions may be pen by an authorised dealer on being satisfied with the circumstances which such substitution has become necessary.

2 [(j)      a person resident in India may, subject to the terms and conditions prescribed by Reserve Bank of India, enter into a forward contract with an authorised dealer in India to hedge an exposure exchange risk in respect of transactions denominated in foreign currency but settled in Indian rupees.]

 

B. Contract other than Forward Contract

 

2. (1)    A person resident in  India who has borrowed foreign exchange accordance with the provisions of Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulations, 2000, may enter into an Interest rate swap or Currency swap or Coupon Swap or Foreign Currency Option or Interest rate cap or collar (Purchases) or Forward Rate Agreement (FRA) contract with an authorised dealer in India or with a branch outside India of an authorised dealer for hedging his loan exposure and unwinding from such hedges

Provided that -

(a)        the contract does not involve rupee.

(b)        the Reserve Bank has accorded final approval for borrowing in foreign currency,

(c)        the notional principal amount of the hedge does not exceed outstanding amount of the foreign currency loan, and

(d)        the maturity of the hedge does not exceed the unexpired maturity of the underlying loan.

 

(2)     A person resident in India, who owes a foreign exchange or rupee liability, may enter into a contract for foreign currency-rupee swap with an authorised dealer in India to hedge long-term exposure

(3)     The contract entered into under sub-paragraph (2), if cancelled shall not be rebooked or re-entered, by whatever name called.

 

3. (1)    A person resident in India may enter into a foreign currency option contract with an authorised dealer in India to hedge foreign exchange exposure of such person arising out of his trade :

 

Provided that in respect of cost effective risk reduction strategies like range forwards, ratio-range forwards or any other variable by whatever name called there shall not be any net inflow of premium. Explanation - The contingent foreign exchange exposure arising out of submission of a tender bid in foreign exchange is also eligible for hedging under this sub-paragraph.

 

(2)        A transaction undertaken under sub-paragraph (1) may be freely booked and/or cancelled.

 

SCHEDULE II

(See regulation 5)

Foreign exchange derivative contracts permissible for a person resident outside India1 

 

1 .        A Registered Foreign Institutional Investor (FII) may enter into a forward contract with rupee as one of the currencies with an authorised dealer in India to hedge its exposure in India

            Provided that

2  [(a)    the value of the hedge does not exceed the market value of the underlying debt or equity instruments, provided forward contracts once booked shall be allowed to continue to the original maturity even if the value of the underlying portfolio shrinks, for reasons other than sale of securities.]

(b)        forward contracts once cancelled shall not he rebooked but may be rolled-over on or before the maturity,

(c)        the cost of hedge is met out of repatriable funds and/or inward remittance through normal banking channel,

(d)        all outward remittances incidental to hedge are net of applicable Indian taxes.

 

2.         A non-resident Indian may enter into forward contract with rupee as one of the currencies, with an authorised dealer in India to hedge;

(a)        the amount of dividend due to him/it on shares held in an Indian company;

(b)        the balances held in Foreign Currency Non-Resident (FCNR) account or non-resident External Rupee (NRE) account;

(c)        the amount of investment made under portfolio scheme in accordance with the provisions of the Foreign Exchange Regulation Act, 1973 or under notifications issued thereunder or is made accordance with the provisions of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations,20001 and in both cases subject to the terms a conditions specified in the proviso to paragraph 1 of this Schedule

2 [2.A                A non-resident Indian may, subject to conditions prescribed by The Reserve Bank of India from time to time, enter into cross currency (not involving the rupee) forward contracts to convert the balances held in FCNR(B) accounts in one foreign currency to another foreign currency in which FCNR(B) deposits are permitted to be maintained.

 

3 [3.                   Authorised dealers may offer forward contracts to persons resident outside India to hedge the investments made in India since January, 1, 1993, subject to verification of the exposure in India. These forward contracts once cancelled are not eligible to be rebooked.]

 

2 [3A.                A person resident outside India may, subject to conditions prescribed by the Reserve Bank of India from time to time, enter into a forward, sale contract with an authorised dealer in India to hedge the currency risk arising out of his proposed foreign direct investment in Indian.

 3B.      A person resident outside India having Foreign Direct Investment in India may, subject to the condition that forward cover shall be taken only after the rate has been approved by the Board, enter into forward contracts with rupee as one of the currencies to hedge the currency risk on dividend receivable by him from the Indian company.]

 

SCHEDULE III

(See Regulation 6)

Procedure for application for approval for hedging of commodity price risk4 

 

1 .        A person resident in India, engaged in export-import trade, 5 [or as permitted by the Reserve Bank] who seeks to hedge price risk in respect of any commodity including gold, 6  [but excluding oil and petroleum products], may submit an application to the International Banking Division of an authorised dealer giving the following details.

 

(i)         A brief description of the hedging strategy proposed; namely:­

(a)        description of business activity and nature of risk;

(b)        instruments proposed to be used for hedging;

(c)        names of commodity exchange and brokers through whom the risk is proposed to be hedged and credit lines propose( be availed. The name and address of the regulatory authority in the country concerned may also be given;

(d)        size/average tenure of exposure and/or total turnover in a year together with expected peak             position thereof and the basis of calculation;

            (ii)        copy of the Risk Management Policy approved by the Management  covering:

(a)        risk identification,

(b)        risk measurements,

(c)        guidelines and procedures to be followed with respect revaluation and/ or monitoring of positions,

(d)        names and designations of the officials authorised to undertake transactions and limits;

(e)        any other relevant information.

2.         Authorised dealer after ensuring that the application is supported documents indicated in paragraph 1 may forward the application its recommendations to Reserve Bank for consideration.

 


 [V1]* vide RBI master circular no 1/2003-04, dt. 1.7.2003

 [M2]Raised from 25% vide AP (Dir Series) Circular no.46 dt 9.12.2003.

 [M3]This limit has been removed vide AP (DIR Series) Circular no.46 dt. 9.12.2003

 [M4]Half-yearly reports of cross-currency derivatives are required to be furnished in the prescribed format, vide AP (DIR Series) Circular No. 32, dt. 21.10.2002.

 [M5]For guidelines/terms and conditions for undertaking hedging transactions by SEZ to AP (DIR Series) Circular No. 44 dt. 12.11.2002.

 [M6]Vide RBI Notification No. FEMA 2512000-RB, dated 3.5.2000.

 [M7]Also refer to RBI Directions issued in this behalf,  vide AP (DIR Series) Circular No. 19, dt. 24.1.2002.

 [M8]Also refer to RBI Directions issued in this behalf,  vide AP (DIR Series) Circular No. 19, dt. 24.1.2002.

 [M9]Inserted vide Notfn . No. FEMA 66/2002-RB, dt. 27.6.2002. Also refer to RBI Directions issued in this regard, Vide AP DIR (Series) Circular No. 44. dt. 12.11.2002.

 [M10]Also refer to RBI Directions issued in this behalf, vide AP (DIR Series) Circular No. 24.1.2002.

 [M11]Subs. for "the authorised dealer through certification of documentary evidence is satisfied about the genuineness of the underlying exposure" vide Notfin. No. FEMA 54/2002-RB, dt. 5.3.2002

 [M12]Substituted for "(h) contracts involving rupee as one of the currencies, once cancelled not be re-booked although they can be rolled over at ongoing rates on or before maturity. This restriction shall not apply to contracts covering export transactions which may be cancelled rebooked or rolled-over at on-going rates" vide Notification No. FEMA 70/RB-2002,dt.26.8.2002.

 [M13]Inserted vide Notification No. FEMA 10412003-RB, dt. 21.10.2003 published in the Gazette of India on 11.11.2003

 [M14]Also refer to RBI Directions issued in this behalf, vide AP (DIR Series) Circular No. 19, dt. 24.1.2002

 [M15]Subs vide Notification No. FEMA 81/2003-RB, dt 8-1-2003 published in the Gazatte of India on 9.7.2003

 [M16]Inserted vide Notification No. FEMA 104/2003-RB, dt. 21.10.2003 published in the Gazette of India on 11.11.2003.

 [M17]Subs. vide Notification No. FEMA 8112003-RB, dt. 8.1.2003, published in the Gazette India on 9.7.2003.

 [M18]Inserted vide Notification No. FEMA 104/2003-RB, dt. 21.10.2003 published in the Gazette of India on 11.11.2003.

 [M19]Also refer to RBI Directions issued in this behalf, vide AP (DIR Series) Circular No. 19, dt. 24.1.2002 and Circular No. 44, dt. 12.11.2002.

 [M20]Vide Notification No. FEMA 105/203-RB dt. 21.10.2003

 [M21]Omitted vide Notification No. FEMA 28/2000- RB dt. 5.9.2000.