Local currency debt vs Hard currency debt
In many markets hard currency debt is quoted at a far lower rate than local borrowing, which makes it look like an easy decision. It is not. The rate difference exists because someone has to carry the currency risk, and unhedged that someone is you.
| Criterion | Local currency debt | Hard currency debt |
|---|---|---|
| Headline rate | Higher in most emerging markets | Lower, sometimes dramatically |
| Currency risk | None if revenue is local | Full exposure unless revenue matches |
| Hedging cost | Not required | Often erases the rate advantage |
| Lender pool | Domestic banks and local funds | International banks and development institutions |
| Tenor | Frequently shorter | Often longer available |
| Best suited to | Domestic revenue businesses | Exporters with hard currency receipts |
The governing principle is simple: borrow in the currency you earn. A business selling domestically that borrows in dollars has created a speculative position on the exchange rate alongside its operating business, and that position can be larger than its annual profit.
Exporters with contracted hard currency receipts are in the opposite position. For them hard currency debt is the natural hedge, not an added risk.
Compare the local rate against the hard currency rate plus the cost of hedging the full exposure for the full tenor. In most markets that comparison narrows sharply, and in some it reverses entirely.
Where hedging is unavailable or prohibitively expensive beyond a short tenor, treat the unhedged exposure as a cost with a wide range of outcomes rather than as a saving.
Businesses with mixed revenue can split borrowing in the same proportion, funding the export element in hard currency and the domestic element locally. That preserves the rate advantage where it is safe to take it.
Development finance institutions increasingly offer local currency lending at longer tenors than domestic banks, which can be the best of both for infrastructure and industrial investment.
Borrow in the currency of your revenue. Take hard currency debt only where receipts match it or where the exposure is fully hedged for the life of the facility.
It can be, where a portion of revenue is naturally matched, but the unhedged remainder should be stress tested against a large adverse move.
Many do where the borrower's revenue does not match the currency, and the requirement is usually written into the facility agreement.
Hard currency and development institution funding often runs longer than domestic bank debt in emerging markets.
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