Key Takeaways:
- Understand major international sources of finance, including GDRs, ADRs, ECBs, FDI, FPI, and Masala Bonds.
- Learn the regulatory framework governing these instruments and their advantages for Indian firms.
- Identify practical risks such as currency and political risk, and see how they're managed in real-world scenarios.
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Introduction to International Sources of Finance
International sources of finance refer to avenues through which firms raise capital from abroad, often denominated in foreign currencies or linked to international investors. In today's globalized environment, Indian companies routinely access such channels for expansion, diversification, and to tap cost-effective funds. Each instrument has unique features, regulatory requirements, and implications for financial management and risk exposure.
Global Depository Receipts (GDRs)
Definition and Mechanism
A Global Depository Receipt (GDR) is a negotiable financial instrument issued by a depository bank, representing shares of a foreign company. Indian companies issue GDRs to raise capital from international investors, typically listed on European stock exchanges. Each GDR corresponds to a fixed number of underlying equity shares.
Regulatory Norms
The issue of GDRs is governed by the Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993, SEBI guidelines, and RBI regulations. Companies must obtain approval from the Ministry of Finance and comply with sectoral caps and end-use restrictions.
Practical Example
Suppose an Indian IT company wants to fund its overseas acquisition. It issues GDRs worth USD 100 million on the London Stock Exchange. The depository bank holds the underlying shares in India and issues GDRs to international investors. The funds are remitted to the Indian company, expanding its global footprint.
American Depository Receipts (ADRs)
Definition and Mechanism
American Depository Receipts (ADRs) are similar to GDRs but specifically designed for trading on U.S. exchanges. An ADR represents shares of a non-U.S. company, held by a U.S. depository bank. This allows Indian firms to access American capital markets and attract U.S. investors.
Regulatory Norms
ADRs are issued under the U.S. Securities and Exchange Commission (SEC) regulations. SEBI and RBI guidelines also apply, ensuring proper disclosures and compliance with foreign investment ceilings.
External Commercial Borrowings (ECBs)
a. Definition and Types
External Commercial Borrowings (ECBs) are loans availed by Indian entities from non-resident lenders in foreign currency. ECBs can take the form of bank loans, buyer’s credit, supplier’s credit, securitized instruments, etc. These funds are typically used for capital expenditure, infrastructure projects, or refinancing existing rupee loans.
b. Regulatory Norms
The RBI’s ECB framework stipulates eligibility, all-in-cost ceilings, end-use restrictions, and reporting requirements. Borrowers must adhere to sector-specific borrowing limits and obtain automatic or approval route clearance based on quantum and tenure.
Foreign Direct Investment (FDI)
a. Definition and Forms
Foreign Direct Investment (FDI) refers to investment by a foreign entity in the equity capital of an Indian company, resulting in significant management influence or control. FDI can come through new ventures, joint ventures, or acquisitions.
b. Regulatory Norms
FDI is governed by the Foreign Exchange Management Act (FEMA) and sector-specific policies set by the Department for Promotion of Industry and Internal Trade (DPIIT). Investments up to prescribed limits are allowed via the automatic route; others require government approval. SEBI and RBI monitor compliance, especially for sensitive sectors.
Foreign Portfolio Investment (FPI)
a. Definition and Distinction
Foreign Portfolio Investment (FPI) involves non-residents investing in Indian securities such as equities, bonds, or mutual funds, without intent to exert control. Unlike FDI, FPI is characterized by passive ownership and quick entry/exit.
b. Regulatory Norms
FPI is regulated by SEBI (FPI) Regulations, 2019. There are eligibility norms for investors, sectoral limits, and mandatory registration with designated depository participants. RBI also imposes aggregate investment limits to prevent excessive foreign ownership in sensitive sectors.
Masala Bonds
Definition and Mechanism
Masala Bonds are rupee-denominated bonds issued by Indian entities in offshore markets, particularly the London Stock Exchange. Unlike other foreign currency bonds, the currency risk is borne by the investor, not the issuer, since repayment is in Indian rupees.
Regulatory Norms
Masala Bonds are subject to RBI’s external commercial borrowing guidelines, with specific rules on eligible issuers, end-use, maturity, and pricing. The framework aims to attract stable, long-term capital and develop the Indian bond market.
Advantages of Raising Funds Abroad
- Access to Large Pools of Capital: International markets offer greater depth, enabling firms to raise substantial funds, often at competitive costs.
- Currency Diversification: Borrowing in foreign currencies can hedge natural exposure for firms with global operations or imports.
- Enhanced Global Presence: Listing via GDRs/ADRs increases brand visibility and credibility among international stakeholders.
- Longer Tenors and Flexible Structures: ECBs and Masala Bonds often provide longer repayment periods and customized structures compared to domestic loans.
- Arbitrage Opportunities: Firms may exploit differences in interest rates and investor appetite across markets.
Risks of International Financing
| Type of Risk | Description | Possible Mitigation |
|---|---|---|
| Currency Risk | Fluctuations in exchange rates can increase the cost of servicing foreign currency debt, impacting profitability. | Hedging through forwards, options, or natural hedges (revenue in foreign currency). |
| Political Risk | Changes in host or home country policies, expropriation, or geopolitical instability may affect capital flows or asset safety. | Political risk insurance, structuring investments via stable jurisdictions. |
| Regulatory Risk | Sudden changes in RBI/SEBI or host country rules can affect repatriation, taxation, or compliance costs. | Regular monitoring, legal counsel, diversified market exposure. |
| Reputational Risk | Failure to meet international covenants or disclosure standards may damage credibility. | Proactive compliance, transparent reporting. |
Example
Step 1: An Indian infrastructure company wants to finance a metro rail project. Domestic loans are expensive, and the repayment period is short.
Step 2: The firm decides to issue Masala Bonds worth INR 1,000 crore in the London market. International investors subscribe to these rupee-denominated bonds, attracted by India's growth story and higher yields.
Step 3: The company receives funds in rupees, uses them for project execution, and commits to repay investors in rupees at maturity. Investors, not the firm, bear the currency risk.
Step 4: Regulatory approvals are secured under RBI guidelines, and the use of proceeds is monitored for compliance.
Key International Instruments
| Instrument | Currency | Regulator | Key Feature |
|---|---|---|---|
| GDR | Foreign (usually USD/Euro) | SEBI, RBI | Listed abroad; underlying shares in India |
| ADR | USD | SEC (USA), SEBI, RBI | Traded on U.S. exchanges |
| ECB | Foreign currencies | RBI | Loans from non-residents; flexible end-use |
| FDI | Foreign currencies | DPIIT, RBI | Ownership/control of Indian firms |
| FPI | Foreign currencies | SEBI, RBI | Portfolio investment; no control |
| Masala Bonds | INR (issued offshore) | RBI | Rupee-denominated; investor bears FX risk |
International sources of finance have revolutionized how Indian firms access capital. Understanding the nuances of each instrument, their regulatory landscape, and the associated risks is essential for strategic decision-making. Reflect on which instrument best suits a firm's objectives and risk appetite. Always remember: prudent financial management is not just about raising funds, but ensuring their sustainability and responsible deployment.