The demonetization of currency notes may have inspired mixed reactions but it has given an unexpected bonanza for dollar borrowers. The flood of liquidity that demonetization brought to the banking sector has driven down the cost of hedging dollar loans. Given that rupees are in copious quantity, the Indian currency has lost its premium and contracts to fix a dollar/rupee exchange rate at a future date are coming cheaper.
In other words, if a company borrows in dollars today and decides to hedge its outflow towards interest payment and maturity by buying forward contracts, it gains immensely. The benchmark one-year forward premium expressed in yield terms has crashed by 170 basis points since 8 November, the day of the demonetization announcement. Before the currency purge, the one-year premium was stubborn around 5.5%. A 100 basis points is equal to 1%.
Contracts to book dollar/rupee exchange rate one-month forward and three-month forward have also fallen by a massive 340 basis points and 230 basis points, respectively. Importers are already thronging the market to hedge.
An indicator of hedge cost for dollar loans is the Mumbai Interbank Forward Offer Rate, which is down by 50 basis points in the three-year tenure since 8 November. In essence, this has made the hedging cost of firms cheaper by at least 50 basis points.
This drop in hedging costs comes at an opportune time as global interest rates are still low. A top rated Indian company can borrow around 200 basis points above the London Interbank Offered Rate or at around 3.3%. On a fully hedged basis, the cost of borrowing would be around 7.5%. A month back, this cost was higher than 8%.
But data from Bloomberg shows that corporates aren’t exactly lining up for dollars. Since demonetization, only two firms have borrowed through dollar loans and no dollar bond issues have been launched since then. Firstly, demand conditions at home are weak and companies won’t borrow if there is no guarantee of using these funds for production. Secondly, a debt overhang is already bogging companies down. But perhaps the most crucial is the good old cost-benefit analysis. Hedge costs may have fallen but so have domestic bond yields. A top rated company can borrow through a three-year domestic bond at 7-7.2% and this is cheaper than dollar borrowings.