Companies to lock foreign loan rates.

Many Indian companies are locking the interest rate on their foreign loans. These loans, better known as external commercial borrowings, are usually given on floating rate of interests that are reset every six months. With US interest rates expected to inch up in the coming months, some of the CFOs and corporate treasurers think it’s the best time to switch their floating rate loans into fixed rate liabilities.

Companies do this by entering into a interest rate swap with a bank. The way rates have moved, a company striking a five-year swap deal can freeze the interest on dollar loans at 1.84% — a rate bankers and treasury risk advisors feel is a good level for the swap. Such a coupon swap will lock in the loan rate at 1.84% for the next five years.
“Companies and financial institutions that have borrowed long-term are the ones who plan to move to fixed rates,” said Hitendra Dave, managing director & head of global markets, HSBC India.

When a corporate takes a foreign loan, it is exposed to interest rate as well as exchange rate risks. Since the loan interest is linked to the London Inter-Bank Offered Rate (Libor) — the international benchmark rate in the bulk money market — corporates pay more as Libor rises. Similarly, the outgo is higher if the dollar rises against the rupee. A corporate with no dollar earnings has to fork out more rupees to buy the same amount of dollar needed to service the interest and repay the loan while there is a natural hedge for exporters with dollar income.

The coupon swap is a hedge against hardening of interest rates, where the risk is passed on to the bank. The bank in turn does back to back deals with another bank or institution to lower its risk. The current Libor is at 0.75% for six months. “It may not be a bad idea to fix one’s interest rates at 1.84% because this brings down the current cost of borrowing to a level much lower than was assumed earlier.

However, there is no pressing immediate need because the borrowers can still enjoy the low floating rates. Going by the US data, the interest rates are going to be low for an extendable period of time, but this is not specifically defined as to how long. So, a part of the borrowings could be locked in at this low rate of interest offered by the swap,” said Ashish Parthasarthy, treasury head of HDFC Bank .

Source : economictimes.indiatimes.com