Rising Libor forces SME to retire foreign loans

A sharp rise in interest rates in the international money markets has led to a mad rush of small and medium enterprises (SME) in advancing payments of their overseas borrowings.

The cost of funds raised overseas has shot up to over 10 per cent from 6-7 per cent about one-and-a-half years ago.

Bankers said the SMEs that borrowed overseas almost a couple of years ago have been badly hit by the rising Libor (London inter-bank offered rate), and the depreciating rupee has exposed them to more shocks.

The interest rates on loans raised overseas are directly related to Libor, which has increased from 1.5-2 per cent nearly two years ago to around 5.5 per cent now. Libor is an international interest rate benchmark based on which coupons on loans get reset every six months.

The depreciating rupee has led to the foreign loans becoming highly expensive as every rise in the dollar means the borrowers have to pay more in rupee terms.

Most of these SMEs, unlike large corporates, have not hedged their foreign currency or interest rate risks. Hedging would have helped them avoid risks emanating from rising interest rates or the adverse exchange rate movement.

Libor has firmed up with the successive hikes in the benchmark US Federal Reserve rate since 2004. The Fed raised its key rate for the seventeenth time, in June, to 5.25 per cent.

The cost of overseas loans has gone up to over 10 per cent with the addition of a spread of 2-3 per cent and withholding tax to the current Libor of around 5.5 per cent.

The total interest cost on foreign funds raised by SMEs is now more than the cost of short-term rupee loans. SMEs can raise short-term loans at 7-9 per cent, depending on the instrument they prefer.

Bankers said these companies are preferring to pay off their foreign currency loans even if they have to pay a penalty because of paying early.

On the other hand, banks active in raising resources for their clients from international markets are increasingly resorting to 'club deals'.

In order to reduce the cost of borrowings, domestic banks are raising foreign currency loans from their correspondent banks. This method of raising funds overseas is called 'club deal'.

In normal syndication, loans are marketed to a host of banks interested in taking exposure to Indian papers. Correspondent banks are banks through which Indian banks conduct certain international operations. The banks in the process of opting for club loans include ICICI Bank and UTI Bank, said bankers.