Dollar a little cheaper for firms but interest bill still high
If one adds the cost of hedging, the total cost of borrowing would be as high as 10% for an investment- grade Indian firm
Hedging a forex loan is almost as expensive as the interest rate that an Indian company promises to pay to get dollars from foreign investors. The chart above shows a sharp rise of 40 basis points in the Mumbai Interbank Forward Offered Rate, which is a gauge of hedge costs. This rise coincides with an increase in the London Interbank Offered Rate (LIBOR) in the global market. Indian firms have to offer a spread over LIBOR to borrow dollars from overseas.
Not only has LIBOR risen, the spread demanded by investors to take on Indian credit risk has also increased. The recent defaults of a large infrastructure group have cast aspersions over the creditworthiness of Indian finance companies. If one adds the cost of hedging, the total cost of borrowing would be as steep as 10% for an investment- grade Indian company. That is at least one percentage point higher than what was demanded a year ago.
In short, borrowing overseas has become a pain for companies. But considering hostile domestic credit markets, companies were willing to fish for funds notwithstanding steep costs. Data shows that companies raised 62% more through external commercial borrowings in the first six months of FY19, compared with the corresponding period last year.
Thus, the Reserve Bank of India’s (RBI’s) relaxation on hedging rules for dollar borrowings earlier this week comes as a much-needed breather. If you are an Indian company wanting to borrow dollars for three-five years, you no longer need to pay through your nose and hedge the entire exposure. The move is expected to give some relief to borrowers as the compulsion to hedge comes down and hence the cost too. State Bank of India’s research wing said in a note that the savings in borrowing cost for companies would come down by 100-120 basis points due to the lowered hedging requirement.
That said Indian companies still have to face the high interest cost and hedge 70% of the loan. Bankers believe that beyond the initial savings in costs, the easing of rules hardly make a material difference to companies.
Another question is whether RBI should encourage build-up of unhedged exposure in the first place after having rapped companies and banks over several years on the same. The argument gains more credence especially in the absence of data of such exposures from the central bank. Independent estimates of unhedged exposures by market participants range from 30-50%.
Editor's Picks »
- Escorts: Japanese joint venture to hone growth in tractors
- HCL Tech’s acquisition of IBM products raises more questions than answers
- Investors ignore NMDC’s price cuts, and worry about its Donimalai iron ore mine instead
- Steel stocks get winter chill as China demand issues resurface
- Why Uday Kotak’s defiance is scaring his bank’s investors