PREFERENCE SHARES TO BE TREATED AS EXTERNAL COMMERCIAL BORROWINGS

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THE unbridled flow of foreign money into India’s property market has run into a wall. The government has made it virtually impossible for builders to sidestep overseas borrowing norms to bring in foreign debt masquerading as equity.

The finance ministry has said that all foreign funds raised by Indian companies through the issue of ‘partially convertible’, ‘non-convertible’ and ‘optionally convertible’ preference shares will be treated as debt and will be subject to guidelines applicable for external commercial borrowings (ECBs).

Significantly, the ministry has also said `convertible preference’ shares will be considered as share capital and should be taken to calculate foreign equity. This will prevent companies, especially in sectors like telecom and insurance, from bypassing the sectoral caps on foreign equity. Convertible preference shares offer the benefit of being converted into ordinary shares on terms and conditions fixed at the time of the issue of such shares.

However, the real impact of the finmin release will be felt by the real estate sector. While the communiqué makes no mention of real estate companies, it’s quite evident that the directive is aimed at tempering fund flow into real estate, with property prices going through the roof. In the past two years, several real estate companies have issued instruments like optionally and partially convertible preference shares to foreign banks and international funds. FDI in real estate jumped 400% to $700 million in 2006. Since such inflow was treated as equity’, money flowed in under the FDI automatic route. This will stop now. From now on, such funds will be treated as ECBs. This will make it difficult for developers to access these funds since ECBs are allowed only in large real estate projects and the conditions are far more stringent than FDI. Besides, it will cap the interest rate that builders can offer to foreign financiers. ECBs can have a maximum interest of 200 basis points above the benchmark Libor for two-year projects and 350 basis points above Libor for five-year projects.

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