The share of External Commercial Borrowing (ECB) in the total external borrowing is rising in India. The government is also progressively relaxing the rules to raise ECB. The present study empirically examines ECB in India and its relationship with the exports, imports, Index of Industrial Production (IIP), Foreign Investment (FI), Exchange Rate (ER) and Interest Rate Differential (IRD) for the period September 1999 to September 2012 on a quarterly basis. It also tries to ascertain the cost of ECB, which normally is believed to be cheaper, against the three currencies—US Dollar (USD), Japanese Yen (JPY) and Great Britain Pound (GBP)—for the period 1978-2011. The methodology adopted for this study is based on the application of time series econometrics. It is observed, on application of Augmented Dicky Fuller test and Phillips-Perron test, that the time series of each variable is non-stationary at level and stationary at first difference and, therefore, is subjected to the analysis as a Vector Error Correction Model (VECM). From the cointegrating vector it is found that there is a significant long-term positive relationship with IIP, IRD and ER and a negative relationship with imports and FI. In the short run, imports, IRD, ER and FI have positive relationship with ECB, while exports and IIP show a negative relationship. The Granger causality test shows that there is a unidirectional causality. The variance decomposition analysis shows that most of the movements in ECB are explained by the IRD, followed by IIP. The ECB in JPY has been found to be cheaper than in the GBP or in USD in most of the years.

In terms of total external debt, India is ranked 30th in the world (The World Factbook, 2011). Since independence, India has been one of the largest borrowers from the external sources. During 1948-49, following the partition, the country faced a severe balance of payment crisis and stood at a massive deficit of US$1,881 mn. This deficit was entirely financed by running down the sterling balances. The strain on the sterling reserves was eased as the external assistance picked up from 1958-59 (Kapur, 1997). The imports, which increased at a faster pace, in comparison to exports, raised the demand for external finance. When the flow of external assistance failed to meet the need for external finance, recourse to External Commercial Borrowing (ECB) was taken (Patnaik, 1987; Khanna, 1992; Singh, 1993; and Kapur, 1997). Since 1980, there has been significant dependence on private capital flows in the form of ECB and deposits from NRIs (Reddy, 2001). Presently, ECB is considered as an effective source of external finance and preferred to domestic debt due to the interest rate advantage. But that the external borrowing in South Asian countries, in the late 1990s of the last century, had led to unprecedented financial crisis (Jalan, 2003), makes it imperative to look critically at the growing dependence on ECB in India which is around 35% of total debt and the government raised the ceiling on the borrowing to $30 bn, and even allowed the borrowers to raise in Chinese Yuan (Krishnan, 2011).

The present study attempts to establish, in the Indian context, the long-run and short- run relationship between ECB, and different macroeconomic variables like imports, exports, Index of Industrial Production (IIP), Exchange Rate (ER), Interest Rate Differential (IRD) and Foreign Investment (FI). The study also examines if the ECB is really cheaper as stated.

Applied Finance Journal,Share of External Commercial Borrowing (ECB) , Index of Industrial Production (IIP),Foreign Investment (FI), Exchange Rate (ER) and Interest Rate Differential (IRD), Vector Error Correction Model (VECM)