The department of economic affairs announced that beginning May 1, all foreign investment coming in as non-convertible, optionally convertible or partially convertible preference shares would be considered debt and come under the overall ambit of external commercial borrowing guidelines and caps.

This is the first time that the ECB cap, which hitherto applied only to debt, will cover a class of shares. The ECB cap for 2007-08 is $22 billion.

In April-December 2006-07, Indian companies raised over $9 billion in ECBs, against $4.3 billion (excluding Indian Millennium Deposit redemptions) in the same period of 05-06.

In addition, any foreign investment coming in as fully convertible preference shares would be treated as part of share capital. It would also be included for calculating foreign equity for sectoral caps.

The finance ministry has also said that any foreign preference shares as on and up to April 30, 2007, would be outside the sectoral cap till their maturity. Issue of preference shares of any type would continue to conform to existing statutory requirements.

The latest policy statement supersedes a Press Note of July 31, 1997, which prescribed the guidelines for Indian companies mobilising foreign investment through preference share issues.

Mukesh Butani, partner, BMR & Associates, said the move would have a major impact spread across sectors. "The government possibly apprehends that a lot of money will come in through this route," he said.

In effect, while the government was of the view that preference shares of any kind were part of equity capital and not ECBs, the new norms change this, said Vivek Mehra, executive director, PricewaterhouseCoopers.

Investment bankers said the finance ministry move was intended to end the misuse of present rules that allow companies to raise overseas funds by issuing quasi-debt instruments such as partly convertible preference or non-convertible shares.

Some real estate companies were using this route to raise funds. Given the stringent conditions for ECBs, these companies would now find it difficult to raise funds.

The move also suggests that no firm can use money raised through preference shares to pre-pay bank borrowing.

"What has been done is to essentially check the wrong use of a financial tool," said the chief financial officer of a leading Delhi-based company.