Mumbai: The Reserve Bank of India’s (RBI's) concessional hedging window was expected to make overseas borrowing an attractive option for public sector companies. Seventy days on, the advantage is already wearing thin. Higher US Treasury yields and a rush of Indian banks into the dollar market have narrowed the cost gap with domestic bonds to just 8-10 basis points (bps), leaving public sector non-banking financial companies (NBFCs) weighing whether to borrow overseas now, wait for better rates, or simply stay home, two PSUs and two merchant bankers said.
The squeeze is coming from both sides. US Treasury yields have climbed, while increased issuance by Indian banks raising dollars to fund foreign-currency non-resident (FCNR) deposits has pushed spreads higher, making dollar borrowing less lucrative for the government-run non-banks.
“The spread has gone up because of supply. When there was not much Indian paper, they used to trade at around 100 bps over US yields. Now, the spreads have gone up, and they are anywhere between 110 and 130 bps,” a senior merchant banker said.
On 5 June, announcing its monetary policy review, RBI announced it will provide a concessional forex swap facility for external commercial borrowings (ECBs) raised by PSUs and banks until 31 December 2026, for a maximum of five-year tenure. Under the scheme, RBI will effectively bear a fixed swap cost of 1.5% per annum for hedging the dollar exposure, allowing borrowers to access overseas funds at significantly lower overall costs.
The cost calculation showed the narrowing gap. For a three-year US dollar bond, a treasury yield of around 4.27%, combined with a spread of about 110 bps, takes the base borrowing cost to roughly 5.37% on a semi-annual basis. The RBI’s 1.5% hedging facility then adds to the effective cost, while another roughly 30 bps may be required for coupon hedging, according to market estimates.
That takes the overall cost of dollar borrowing to around 7.20% compared with domestic bond yields of around 7.28-7.30% for the PSU issuers. The difference is a mere 8-10 basis points, significantly reducing the incentive to borrow abroad. Coupon hedging refers to hedging the periodic interest payments on a foreign-currency borrowing. The RBI facility does not cover this component, which can add roughly another 30 bps to the cost.
Currently, dollar-rupee forward rates are hovering a tad over 3% annually.
An email sent to public sector non-banks Rural Electrification Corp (REC), Power Finance Corp (PFC) and Housing Urban Development Corp Ltd (Hudco) did not elicit any response until press time.
“From a rate perspective, the difference is narrowing and that is one thing to worry about,” said the senior banker cited above.
On 7 August, frequent AAA rated issuers such as REC raised ₹3,000 crore through domestic bonds maturing in three years at 7.28% and ₹3,346 crore via 15-year paper at 7.49%. Last month, Small Industries Development Bank of India (Sidbi) raised ₹8,000 crore via November 2029 bond at 7.29%, merchant bankers said.
“The RBI window has created an alternative funding channel, but it has not made overseas funding an automatic winner. Elevated US yields have narrowed the pricing advantage of ECBs over domestic funding, while PSU domestic bond borrowings themselves have weakened amid elevated and volatile bond yields,” Venkatakrishnan Srinivasan, founder of Rockford Fincap said.
Since the US-Iran war broke out on 28 February, yield on the 10-year benchmark US treasury yield has gone up by 65 bps to 4.68%, while that of the corresponding domestic government bond yield is up only 10 bps to 6.78% as of 11 August, Bloomberg data showed.
The overseas market has also become crowded, as banks have been raising US dollars to fund the FCNR deposits that has created a supply overhang in the dollar market for PSUs.
According to data released by RBI on 1 August, banks raised around $36.73 billion through the FCNR route until 31 July and the market expects the mobilization to reach around $90 billion by September end, when the special FCNR deposit window closes.
Overseas foreign currency borrowings have garnered $2.58 billion, with the response from ECBs underwhelming at $1.52 billion under the scheme.
“Mostly, we have seen only a few banks have raised. If the big banks are raising, obviously there is some crowding out happening. Possibly, the PSUs will wait for some time, prepare the paperwork and then tap," said Soumyajit Niyogi, director at India Ratings and Research.
So far, State Bank of India, HDFC Bank, ICICI Bank and Axis Bank have tapped the offshore market to raise largely term loans.
Among the PSUs, PFC has raised $300 million via five-year dollar-denominated bond and National Bank for Financing Infrastructure and Development (NaBFID) have raised $850 million via term-loans. NaBFID last month raised $850 million via term-loans at secured overnight financing rate (SOFR) plus 120 bps, managing director Rajkiran Rai told Mint. SOFR, trading at 3.64%, is a broad measure of the cost of borrowing cash overnight collateralized by treasury securities.
For PSUs, the expectation is that borrowing activity could pick up after September once the FCNR mobilization window closes and some of the supply pressure eases.
Yet, waiting also carries a risk. US Treasury yields could move in either direction depending on the Federal Reserve’s rate trajectory, inflation and labour-market conditions. A weaker US labour market could support lower yields and make it worthwhile for Indian issuers to wait, while persistent inflation and higher crude oil prices amid geopolitical tensions could keep yields elevated or push them higher.
Some NBFCs are also looking at overseas borrowing as a diversification tool, rather than purely as a cheaper source of funds. Dollar funding gives access to a wider investor base, including those who may not have sufficient limits to invest in Indian domestic debt.
The current preference appears to be for overseas term loans, rather than dollar-denominated bonds.
“First, the yield should come down, then only we can go for US bond issuances,” a senior PSU official said on the condition of anonymity. The official said that term loans, particularly those raised through international financial hub Gift City, remain more viable because they do not attract the same withholding-tax burden as bonds.
“In terms of bonds, your coupon gets fixed for five years. In term loans, there is a variable rate,” the official said. “Bond is not viable at all…You will not find any PSU getting into the bond market.”
“With bank and short-term funding also remaining competitive, PSU NBFCs now have to optimize their funding mix across overseas borrowing, domestic bonds and bank funding, rather than simply chase the cheapest headline rate,” Srinivasan said.