It’s a myth; US dollar loans are not cheap (Final)
The picture under a fixed-rate loan scenario is broadly similar to that of floating-rate in that the trend in capital repayments under both FCY and LCY loans are the same—the LCY capital repayments are the same on quarterly basis but the FCY loan repayments escalate in line with the depreciation of the cedi (see Fig 3).
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The difference lies with the interest service curves, which more or less reduce linearly in line with reducing outstanding exposures under both loans. However, the benefits to the LCY loan (lower debt payments) come much earlier in 2009, see Fig 4, as the adverse impact of the increased T-bill rate to the LCY loan is absent in this scenario.
You would notice that the initial big gap between the interest service curves under the floating-rate scenario is absent under the fixed-rate scenario. Thus the off-setting effect of the interest savings under the FCY loan is absent.
In summary the cedi borrowing was cheaper for loans contracted in 2008 and maturing in 2015. The main reason is the cedi depreciation which resulted in astronomical increases in capital repayments for the FCY loan over the period.
Effect of timing on the relative costs of FCY and LCY loans
Given that the key drivers for the debt service amount differentials (the exchange and T-bill rates) have varied significantly over time (see again Fig. 7), the cost/payment differentials could differ depending on the period the loans were outstanding.
Such information could help explain why the perception that FCY loans are cheaper is so widespread. For instance if this were true for say the early part of the eight-year period considered, one can understand why such perception would persist even if the benefits diminish over time.
I present in the two charts below the excess FCY loan payments over the LCY loan for different time windows.
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In order to explain the outcome we define “Excess” as the amount by which total debt service under the FCY loan exceeds that under LCY loan.
Thus any positive Excess would imply expensive FCY loan relative to the LCY loan and vice versa. Also in order to capture the results of both earlier and recent times, I have considered different sub-periods within the 2008-2015 range by looking at the usual medium term lending tenors in the market: three, five and six-year loans with one set having January 2008 as the reference and starting year, while the other set has December 2015 as the reference and maturing date.
In all, I formulated six sub-periods. The results show that the benefits to the cedi loan are not limited to loans that run for the entire period of Jan 2008 – Dec 2015, but pertain in each of the different sub-periods. For all six sub-periods considered under both floating-rate and fixed-rate loans, it would have been cheaper to borrow cedis (see Fig. 5 and Fig. 6) although the excess payments under the fixed-rate loan for the 2010-2015 sub-period is only two per cent.
The pricing for the LCY loan would have been much higher given the 91-day T-bill rate of about 22.5 per cent in January 2010. The effect of the T-bill rate prevailing on date of fixing price is evident in the reverse under the 2011-2015 scenario where the 91-day T-bill was about 12 per cent.
It must be noted that even though the Excess is driven by the interest and exchange rates, the interplay between these two factors is not necessarily linear. Their impact is affected by other factors such as tenor via the speed with which
It must be noted that even though the Excess is driven by the interest and exchange rates, the interplay between these two factors is not necessarily linear. Their impact is affected by other factors such as tenor via the speed with which debt is amortised.
The impact of what margins are charged (and for that matter interest rates) has also been investigated in this section. The aim here is to establish whether or not the reported benefits of LCY loans are due to the pricing assumed for an “average” company in Ghana.
Table 3 and Table 4 below show Excess (as defined earlier) for different combinations of LCY and FCY interest margins for floating-rate and fixed-rate loans for the period Jan 2008 – Dec 2015.
In each table, the assumed interest margins over LIBOR for the FCY loan are shown horizontally in the shaded row while that for the LCY over T-bill are shown vertically in the shaded column.
The resulting Excess for each combination of interest margin for both FCY and LCY over their respective base rates are presented in the unshaded section of each table with the base case scenarios highlighted in dotted squares.
All positive percentages indicate the extent of savings under the LCY loan compared to the FCY equivalent loan and vice versa.
Under the floating-rate the FCY loan would only have been cheaper if it was priced at a margin of four per cent (or lower) over LIBOR, while at the same time the LCY loan was priced at a margin of 16 per cent (or higher).
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In other words the LCY borrower would still have made some savings compared to the FCY borrower if the average interest rate on the LCY loan was 33.90 per cent per annum (p.a.), (i.e. average 91-day T-bill of 19.9% +14.0% p.a.) and that on the FCY loan was 4.67 per cent p.a. (i.e. average three-month LIBOR of 0.67%+4.0% p.a.).
I think such pricing on the cedi loan would be unrealistic (at least in those days) even if the average firm could raise USD term debt at 4.65 per cent p.a. over the tenor.
The margin differential required for the FCY loan to be cheaper is even more unrealistic under fixed-rate as all combinations considered per Table 4 produced outcome in favor of the LCY loan.
Trends in the key drivers: interest & exchange rates
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The nature of interest rates and the stability of the local currency have been well ventilated in the media, as such only brief comments are provided and limited to just the trends as other important matters such as causes are less relevant to this analysis.
From Fig. 7 the local currency has depreciated at an average rate of about four per cent per quarter (about 15% p.a.) against the USD since 2008. Given that depreciation is a key driver of Excess payment under FCY loans, the benefits of local currency borrowing have increased over time in line with the exchange rate.
The typical steep depreciation trend in election years appears to be changing. Over the period the sharpest depreciation recorded was between 2013 and 2015, which were non-election years.
In respect of the interest rates the 91day T-bill had fluctuated significantly between 2008 and 2012, approximating an S-shape. From about 16 per cent in June 2008 the T-bill rate increased to almost 26 per cent in September 2009, dropped to about nine per cent in September 2011 before rising up again to peak at about 23 per cent in December 2012.
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For the remainder of the period it has generally been flat with the exception of a dip in December 2013. On the contrary, LIBOR remained low and almost flat over the entire period after a brief decline between 2008 and 2009.
However, despite the wide gap between these two metrics, the benefits of borrowing in either currency have been driven largely by exchange rate due to the impact on capital repayments.
It has been established from the historical data that for periods where the exchange rate remained relatively stable, such as June 2009-December 2011 and June 2012-September 2013 (see Fig. 7), the Excess debt service turns negative in favour of the FCY loan, making the FCY loan up to 11.5 per cent cheaper based on the Base Case pricing.
Note that these periods of relative stability for the cedi are only deniable hindsight.
Key conclusions
• Borrowing in USD is not cheap: borrowing in local currency is cheaper compared to borrowing in foreign currency. This conclusion is robust and persists under different time/periods and pricing scenarios. Indeed the benefit of borrowing in local currency has been increasing over time.
• The ‘devil’ is in capital repayments: the interest cost “savings” on USD loans is often more than offset by escalation in capital repayment in cedi terms under foreign currency borrowing as USD borrowers have to ‘buy’ USD for both capital repayments and interest service at increasing prices (exchange rates).
• The findings are relevant to all borrowers regardless of currency of earnings: the findings have implications for both USD and Cedi earners—borrowing USD would have resulted in paying a lot more to lenders (in cedis) although the situation could have been worse with a local currency earner. However, the USD earner could still have made significant savings by borrowing in cedis.