Companies with revenues in local currency should generally borrow in their local currency, instead of borrowing in a foreign currency which leads to currency risk. By matching the currency denomination of assets and liabilities, companies can concentrate on their core businesses rather than worry about exchange rate volatility. The financial crises which have affected emerging markets in recent years demonstrated that even stable exchange rate regimes may not hold in times of crisis, and therefore being hedged against currency risk is a prudent financial strategy.
IFC has also made local currency financing a priority in order to help develop local capital markets. In addition, we are keenly aware that companies which receive financing in the same currency as their revenues are more creditworthy clients for IFC.
How IFC Provides Local Currency Loans and Hedges
IFC provides local currency debt financing in three ways: (1) loans from IFC denominated in local currency; (2) risk management swaps which allow clients to hedge existing or new foreign currency denominated liabilities back into local currency; and (3) Structured Financewhich enable clients to borrow in local currency from other sources. This note will explore further the first two of these mechanisms.
Collectively, local currency financing through loans or swaps is made possible by the existence of a swap or, more generally speaking, derivatives market. The existence of a long-term swap market between the local currency and dollars permits IFC to hedge its loans in the local currency and provide risk management products tied to the loan currency. Please see the markets in which long-term local currency swaps are currently available.
Local currency loan from IFC:
IFC disburses in local currency and the client repays in local currency. Based on the preference of the client, the loan can carry a fixed rate or a variable rate. Variable rate loans depend on the availability of a liquid local reference rate, usually a short term interbank lending rate or government securities rate. The repayment terms for local currency loans are customized to meet the needs of the client. IFC stands ready to provide long-term local currency loans in over a dozen emerging market currencies.
The diagrams below show the cash flows associated with a Mexican peso loan at disbursement and over time.
Cash Flows at Disbursement
Cash Flows Over Time
Local currency swap from IFC:
Through an overlay currency swap, IFC allows clients to transform existing or new foreign currency liabilities into local currency. The foreign currency liability can be from any third party source such as a bank loan or bond issue. The currency swap can be tailored so that currency payments from IFC to the client exactly offset currency payments owed by the client under the foreign currency borrowing. By providing clients with hedging instruments which they would otherwise not be able to access, IFC helps clients achieve sythetic local currency financing.
The diagram below shows the cash flows associated with a Thai baht/US dollar currency swap over time: