Yen borrowings may turn riskier on dollar gains

Indian corporates' increasing preference for yen borrowings is seen turning riskier with the rising US interest rates.

"The rising US interest rates could put yen as a funding currency at risk," said David Woo, director, head of foreign exchange strategy at Barclays Capital, the investment banking division of Barclays Bank Plc.

Dollar will strengthen against the euro as the widening divergence in interest rates in the US and the eurozone is beneficial for the US currency.

"What's important for the dollar is that the European Central Bank won't alter interest rate as the data has showed deceleration in money supply," Woo told Business Standard.

The dollar has gained about 12 per cent against the euro and 10 per cent against the yen since January 2005, thanks to the widening difference between the US and eurozone interest rates.

The fall of the euro below psychologically important $1.20 level is already seen leading to hedging of positions against further dollar strength.

The euro had hit a lifetime high of $1.36 towards the end of December 2004 and is now ruling around a 14-month low.

Major economies are going through different interest rate cycles. The US Federal Reserve will keep increasing its interest rates, European Central Bank would desist from doing so and Japanese rates will remain where they are.

The US Federal Reserve raised its funds rate last week for the ninth consecutive time by 0.25 per cent to 3.25 per cent.

The dollar's broadening rate advantage has dwarfed negative factors such as the huge US current account deficit.

The strengthening of the dollar has taken everyone by surprise, including the hedge funds. Hedge funds have taken a hit in 2005 as they too did not expect the dollar to gain so much, said Barclay's Woo.

Power Finance Corporation (PFC) and Housing Development Finance Corporation (HDFC) have refinanced their five-year loans raised in 2002-03 with fresh borrowings of yen 12 billion each (about $100 million) for less than three year period.

Borrowings in yen is the latest trend as the cost of funds works out cheaper.

Indian corporates borrowing in yen convert the funds into dollars before transferring the money home, hence have to undertake a two-step hedging "" one, to hedge dollar-yen currency risk and the second, to hedge dollar-rupee currency risk.

The primary benefit of borrowing in the Japanese currency is a lower withholding tax, said Madan Menon, co-CEO, Barclays Capital India.

There's also an increasing appetite in Japan for Indian papers and which is demonstrated by a large number of mutual funds being launched there, specifically for India.

The rise in yen borrowing by Indian corporates is a matching of needs for funds and investment avenues, said Lutfey Siddiqi, Singapore -based director of Barclays Capital.