The rupee has crossed the psychological barrier of Rs 50 against the US dollar recently, raising concern among corporates regarding their foreign currency borrowing plans. But the prevailing low interest rates globally, and the reasonably developed market for long-term foreign currency exchanges make a compelling case for foreign currency borrowings, which are significantly cheaper than rupee borrowings.

A historical perspective on foreign exchange rates reveals interesting facts. While the pace of recent depreciation may have come as a surprise to many, the exchange rate is still within the levels recorded in the past. Ten years ago, the exchange rate was Rs 48.03 against the dollar, yielding an average annual depreciation of 0.4 per cent. Given this history, and the current state of global and Indian economy, it can be reasonably assumed that, during the next ten years, the chances of rupee strengthening are higher than significant depreciation from current levels.

INSULATED FROM FLUCTUATIONS

However, foreign currency borrowings can be availed without taking any exposure to currency fluctuations. Long-term foreign currency borrowings can be fully covered through exchanges for the entire loan tenure, insulating corporates from exchange rate fluctuations. Large corporates have been availing foreign currency borrowings for many years. But mid-size corporates and SMEs haven't been active in availing foreign currency loans, perhaps due to risk aversion. The interest cost savings in foreign currency borrowings, however, is significant in today's market, making it an attractive choice.

Certain operational restrictions could make foreign currency borrowings more cumbersome than rupee borrowings. A key constraint is in the end-use of funds; proceeds from foreign currency loans can be used only towards prospective capital expenditure, and not against working capital funding, repayment of existing debt, reimbursement of capital expenditure already incurred, or general corporate purposes. Besides this, prepayment of foreign currency loan is subject to regulatory restrictions.

A key aspect an SME should bear in mind is regarding leaving the foreign currency loan unhedged. The cost of covering the foreign exchange loan is almost half the cost of the foreign currency loan. This may cause serious damage to the financial health of the corporate, if the rupee depreciates against the dollar.

(The author is ex-Director Ratings, CRISIL and Co-founder, RiverBridge Investment Advisors.)

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