India Inc may lose yen for Japanese loans

India Inc may lose its appetite for Japanese yen borrowings as the cost advantage vis-a-vis dollar loans will substantially diminish following the Bank of Japan's decision to raise the overnight rate to 0.25 per cent, ending the six-year regime of zero interest rate.

Bankers said the cost advantage of raising resources in yen was about 50-75 basis points, and the Japanese central bank's decision to increase interest rates would narrow the cost differential to a level which would gradually make borrowing in yen much less attractive.

According to the bankers, the 25-basis-point hike in the benchmark rate was not substantial enough to push up interest rates for corporates. But they added that borrowing plans would be affected materially if the central bank embarked on successive hikes.

Indian entities borrowing overseas are required to pay withholding tax on the interest outgo from India.

The incidence of withholding tax on yen borrowings is much lower compared with dollar borrowings because of the interest rate differential. The quantum of withholding tax varies between 10 and 15 per cent of the interest cost, depending on the country to which the interest is remitted.

While a normal dollar loan costs around 7.5 per cent, the cost of a yen loan could be as low as 2.5 per cent. This will now go up.

However, corporations do not get the entire advantage as they need to take forward cover for their yen loans, and swap it with dollar exposure.

In other words, they need to hedge their exposures against any currency risk.

Unless this is done, they will end up paying more if yen appreciates against the dollar. A few corporates had not been taking the forward cover as yen was going down against the dollar, and, thereby, enjoying a cost advantage.

However, with the rise in rates, the yen will rise against the dollar, and the borrowers cannot afford to keep their positions open without taking any forward cover. "The forward cost will go up, and on a fully hedged basis, a yen loan may not remain cheap any more," said an investment banker.

The Development Finance Corporation, Industrial Development Bank of India, Exim Bank and several corporates have taken the yen route for overseas borrowing to save on costs.

Meanwhile, bond yields hit a four-and-a-half-year high today in response to the Bank of Japan decision. The 10-year bond yield touched a high of 8.38 per cent before closing at 8.34 per cent, as traders drew comfort from the slower-than-expected increase in the wholesale price index, which rose 4.96 per cent in the 12 months to July 1, but above the previous week's 4.84 per cent.