Balanced approach essential on foreign currency debt

Welcome Guest! You are here: Home » Views & Analysis

Balanced approach essential on foreign currency debt

A sustainable long-term focused borrowing strategy will be the key differentiator for successful businesses

Saturday April 20, 2019 8:05 PM, Taponeel Mukherjee, IANS

Dollar Bond

Recent news about an increase in Indian corporates and state entities issuing dollar bonds is welcome news, especially since it clearly shows investor appetite for lending to credible Indian business models. However, relatively easy liquidity and high investor appetite for lending in the international markets must be tempered by the fact that borrowing in foreign currencies is beneficial for businesses with certain specific balance sheet structures.

Foreign Borrowings

While relatively low interest rates abroad and increasing investor demand for relatively good quality debt assists in borrowing for Indian businesses, it is essential to realise that severe foreign exchange rate fluctuations can severely impact the debt servicing capacity of a company that relies excessively on foreign borrowings.

For businesses that have assets creating dollar cash flows, borrowing in the currency makes sense. For instance, for an exporter of products or services to the United States with a dollar-based stream of income, financing greenback liabilities is more feasible. While macro factors are beyond the control of a business, understanding and creating a well-balanced balance sheet is something that deserves attention. Not only is it essential for a balance between assets that can generate cash flows to match liability outflows, in the case of multiple currencies, it is vital that currency mismatches are avoided as far as possible.

For businesses looking to take on foreign currency denominated debt, it is essential that there is a long-term focus on how foreign exchange volatility will be dealt with. For firms that do not have dollar-based assets that generate foreign currency denominated cash flows, prudence is advised on foreign currency borrowings.

Debt Servicing

While the appreciation of the Indian rupee can lead to windfall gains by way of lower interest and principal payments, a severe depreciation of the currency, a factor beyond the control of a business, can leave the company in a precarious position with debt servicing. Most importantly, the company might be in the sectors of financial services, energy or IT services, and therefore being exposed to the macro-vagaries of the foreign exchange market for business success is not an ideal situation to be in.

2008 Financial Crisis

The experiences of European and Japanese financial institutions during the 2008 financial crisis are a good reminder of the perils of creating excessive dollar-denominated liabilities while owning assets primarily in domestic currencies.

Balance sheet imbalances and a shortage of dollar funding precipitated a crisis that severely damaged the financial systems and institutions in Europe and Japan. One major takeaway from the 2008 crisis was that creating an imbalanced balance sheet renders the business exposed to risks, managing which is inherently not the core objective of the company.

For instance, an energy developer facing severe pressure to fund dollar liabilities isn't ideal. The funding pressure may lead to a situation in which despite having a robust energy business, the energy developer might be severely loss-making due to a significant change in the cost of foreign liabilities that need to be paid off.

The decision of how much of liabilities must be in a foreign currency is no less important than the choice of how much debt a business must utilise. While the decision around leverage is driven by the quality of cash flows that a company has to finance the future liability payments, i.e. interest payments, the decision around the currency to be utilised must also be factored in separately.

Volatility In Currency

Effectively, the risk a business undertakes in using foreign currency debt must factor in the volatility in the currency pair that is applicable in terms of the cash flows and liability payments. For instance, if a business receives all incoming cash flows in Indian rupees, then the amount of dollar-denominated debt ideal for the company needs to be carefully evaluated.

In a world with relatively low yields, especially in the developed economies, and a growing economy such as India, the interest to lend to Indian businesses by global investors is inevitable. For any business, the focus must be on creating a long-term track record of utilising foreign currency denominated debt effectively to either take advantage of relatively low-interest rates or potentially finance international growth.

However, prudent usage of foreign debt by Indian business is also vital to ensure that investor confidence builds up for both individual companies and Indian firms in general. Judicious usage of foreign currency debt is critical for the long-term goal of increased access to global capital markets for Indian companies.

As with financial structures and balance sheet decisions, there is no one-size-fits-all solution for foreign currency borrowings. A sustainable long-term focused borrowing strategy will be the key differentiator for successful businesses.

(Taponeel Mukherjee heads Development Tracks, an infrastructure advisory firm. He is reachable at taponeel.mukherjee@development-tracks.com or @Taponeel on Twitter. Disclaimer: The views expressed in this column are strictly those of the author and not of the IANS)

For all the latest News, Opinions and Views, download ummid.com App.

Select Language To Read in Urdu, Hindi, Marathi or Arabic.