The Hindu Business Line : Fed fund rate hike makes ECBs dearer

The hike has reduced the differential between the domestic and international borrowing costs. This is because borrowing in the international markets also means hedging and administrative costs of at least three per cent.

Bangalore , May 11

External commercial borrowings (ECBs) have become more expensive after the 25 basis points hike in the Federal Funds (FedFunds) Rate.

After the Federal Reserve Board's funds rate (the rate at which banks lend overnight funds to each other) hike to five per cent on May 10, six-month London Inter-bank offered rates or LIBOR shot up to 5.3 per cent.

Most domestic corporates have raised ECBs at floating rates linked to LIBOR. The funds were raised at spreads of 100 points and above over LIBOR in the case of the blue chips.

Second-rung corporates have raised the funds at even higher spreads or in the form of convertibles.

Banking sources said that with the increase, the interest costs of corporates are expected to show sharp increases.

While the spreads would remain unchanged, absolute interest servicing costs are likely to escalate.

Differential narrows

The hike has also reduced the difference between domestic borrowing and international borrowing costs.

This is because borrowing in the international markets also means hedging and administrative costs of at least three per cent. This would imply that the effective servicing costs of ECBs would be about eight per cent.

In the domestic market, however, many of the corporate borrowers have been raising funds at almost equivalent rates.

Currently AA rated corporates are raising term funds in the domestic markets at fixed rates as low as 8.25 per cent with three-year resets.

Floating rate borrowings are available at even lower rates of eight per cent with six-monthly or quarterly resets linked to the benchmark prime lending rate or BPLR. Currently, the prevailing rates for top rated corporates are BPLR minus 300 basis points.

Unhedged borrowings

Bankers said that many of the corporates had left their borrowings unhedged. This was despite the Reserve Bank of India's repeated warnings against unhedged exposures.

The bankers said that many of them had preferred to leave the exposures unhedged in view of the current stability of the rupee against the dollar.

Besides, many have taken the view that the dollar was likely to further depreciate against the rupee.

Since the beginning of this year, the rupee has tended to appreciate against the dollar. In January it was at 45.05. Now it is 44.93.

If the dollar indeed depreciates against the rupee, these corporates would actually be saving on their debt service costs as they would be able to obtain more dollars for less rupee funds.

Some of the corporates have natural hedges against their foreign exposures in the form of foreign currency earnings.

But bankers said that oil companies with very little foreign currency earnings were the ones that had left their external exposures unhedged.

The sources said that the companies were resorting to this trend in view of the large under recoveries. Bankers said that in the event of the exchange rate moving in the opposite direction, these would be most impacted.

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Fed fund rate hike makes ECBs dearer