Why taking ECBs in EURO is beneficial?

Before looking at benefit of taking ECB Loan in Euro, let’s understand ECB Loans first

ECB Loan:

External Commercial Borrowing(ECB) Loans are loans sourced from a non resident lender to an Indian borrowers. ECB Loans are given in foreign currency and used widely in India to facilitate foreign money access by Indian Corporates. ECB Loans include Commercial Bank Loans, buyer’s credit, supplier’s credit etc.

As per earlier guidelines of RBI, ECBs cannot be used for Real Estate and Speculation in Stock Markets. But as per revised guidelines issues by Reserve Bank of India on ECB Loans on 30^th July, 2019 it is now permitted to be used for general corporate purposes apart from working capital. It can be interpreted safely that this opens up ECB to investment even in Real Estate if it is used for the corporate purposes like setting up on office premises, plants etc.  General Corporate purpose can also be construed to be investment opportunities also in the form of stocks, companies or share buy backs. To read more about these changes in ECB Loans click here. As per the revised guidelines ECB Loans can also be used for repayment of rupee loans.

What is LIBOR?

LIBOR stands for London Interbank Offered Rate. It is the rate at which banks borrow money from each another. It is administered by International Exchange(ICE) Benchmark Administration.

LIBOR publishes daily average interest rates for five currencies namely USD, Euro, Pound, Yen and Swiss Franc across seven different tenors(overnights, one week, one, two, three, six and twelve months).

LIBOR in different currency:

6 months USD Libor – 

As it can be seen  from the chart of 6 months USD LIBOR interest rates have been falling since reaching its highest in more than decade in 2018. Fed’s rate hikes, increasing US borrowings and its balance sheet shrinking had pushed the 6 months USD Libor to its peak. However in 2019 it has started to fall largely based on Fed’s stance of not hiking the interest rate in 2019. Most recently US yield curves inverted deeper which increasingly higher concerns that the US economy is headed for recession. Libor likely to go further down

Another advantage of taking loans in USD LIBOR is that US Dollar is a relatively safe currency and would not show much of currency movement. This helps businesses as they do not have to worry about volatility.

6 months Euro Libor –

As it can be seen in the chart, 6 months EURO LIBOR has been declining since 2015 and is currently negative. This primarily implies the lowest cost loans can be sourced in EURO for businesses. One factor that needs to be considered is that EURO itself has been fluctuating and with BREXIT concerns hovering over Europe, there is always the currency risk with EURO. So lower interest rates of EURO LIBOR versus USD LIBOR also need to take into account increased currency risk in the overall interest rate calculations.

6 Months Yen Libor –

The USDCNY currency pair is one of the most commonly used currency pair second only to EUR/USD –Also because it values two of the largest three economies of the world, this currency pair in effect is also an indicator of not only Japan’s economy but also an indicator of Asian Economic health and to some extent global economic health. USD-YEN currency charges seem to be indicating problems ahead for Japanese Yen as Dollar may decline with interest rate cut, hence devaluing investments. From an interest rate perspective As can be seen from above YEN LIBOR is also hovering around zero to negative interest rate. Problem with YEN is similar to that of Europe but to a slightly lower extent.

Why is LIBOR important when considering ECB Loans?

ECB Loans are loans in foreign currency. All foreign currency loan use LIBOR as the benchmark rates and add credit risk spreads to LIBOR to cover the risks. In order to understand ECB loans structuring it is important to understand LIBOR and credit spread that gets added to it.

You can contact our ECB Consultants to get a reasonable estimate of interest rates prevalent in your Industry and all the components that will decide your risk profile that helps calculate Interest Rate in India for your business. Contact Us to know more.

Benefit of taking ECB in Euro LIBOR:

As it can be seen from the charts above EURO LIBOR has been falling for last ten years. It is forecasted to go further down. EURO LIBOR is witnessing such a trend across all the tenors from overnight to twelve months. With world facing economic slowdown and central banks facing pressure to boost growth, bringing interest rate down is one tool that is being used often. As per our forecast, EURO LIBOR will continue to be negative going forward.

Example  – the spread is 2%

It is advisable to take ECB in EURO as the final interest cost would be very low.