LOCAL CURRENCY
FINANCING
MANAGING YOUR CURRENCY RISK
HOW CAN
WECAN
FINDWE
AFFORDABLE
FINANCING
HOW
FIND AFFORDABLE
FINANCING
WITHOUT
RUNNING
UNNECESSARY
RISKS? THIS
WITHOUT
RUNNING
UNNECESSARY
RISKS? THIS
IS THE CRUCIAL
QUESTION
FACING FACING
COMPANIES
IS THE CRUCIAL
QUESTION
COMPANIES
LOOKING
TO EXPAND
THEIR OPERATIONS,
LOOKING
TO EXPAND
THEIR OPERATIONS,
FINANCIAL
INSTITUTIONS
PROVIDING
SMALL AND
FINANCIAL
INSTITUTIONS
PROVIDING
SMALL AND
MEDIUM
ENTERPRISES
WITH CAPITAL,
OR PUBLICMEDIUM
ENTERPRISES
WITH CAPITAL,
OR PUBLICPRIVATEPRIVATE
PARTNERSHIPS
WORKING
ON LARGEPARTNERSHIPS
WORKING
ON LARGESCALE ENERGY
OR INFRASTRUCTURE
PROJECTS.
SCALE ENERGY
OR INFRASTRUCTURE
PROJECTS.
LOCAL CURRENCY
FINANCING
example,example,
if a company’s
revenue is
in its local
if a company’s
revenue
is in currency
its local currency FMO canFMO
provide
can local
provide
currency
local currency
financingfinancing
for new or
for new or
Borrowing
in foreign
may seem
attractive,
Borrowing
incurrencies
foreign currencies
may
seem attractive, LOCAL CURRENCY
LOCAL CURRENCY
FINANCING:
FINANCING:
but it’s an
option
not
entirely
fromfree
risk.from
For risk. For HOW DOES
but
it’s anthat’s
option
that’s
not free
entirely
HOWITDOES
WORK?
IT WORK?
and thatand
currency
should devalue,
or if a foreign
that currency
should devalue,
or if a foreign
existing YOUR
loans
existing
using
loans
various
usingstructures,
various
structures,
depending
depending
on
on
MANAGING
CURRENCY
RISK
currency currency
strengthens,
foreign currency
borrowing
strengthens,
foreign currency
borrowing
availability
availability
and aspects
andsuch
aspects
as underlying
such as underlying
loan obligatiloan obligati-
obligations
will increase.
This will This
potentially
threaten threaten ons, localons,
obligations
will increase.
will potentially
market
localconditions,
market conditions,
and legaland
andlegal
institutional
and institutional
the company’s
continuity.
So why run
this risk?
the company’s
continuity.
So why
run this risk?
frameworks.
frameworks.
PaymentsPayments
of principal
of principal
and interest
and can
interest
be incan be in
either currency,
either currency,
subject to
subject
availability,
to availability,
althoughalthough
the
the
FMO provides
local currency
financingfinancing
that maythat
reduce
FMO provides
local currency
may reducepaymentpayment
will be based
will be
onbased
a fixed
onlocal
a fixed
currency
local currency
amount. amount.
your risk your
of losses
from
such
currency
mismatches.
risk of
losses
from
such currency
mismatches.
DEPENDING
DEPENDING
ON AVAILABILITY,
ON AVAILABILITY,
LOCAL LOCAL
CURRENCY
CURRENCY
FINANCING
FINANCING
MAY CONSIST
MAY CONSIST
OF:
OF:
BENEFITS
OF CURRENCY
LOCAL CURRENCY
FINANCING
BENEFITS
OF LOCAL
FINANCING
Local currency
financing
can potentially
Local currency
financing
can potentially
provide provide
protection
from aof
variety
of currency
protection
from a variety
currency
risks, risks,
including:
including:
• Increasing
debt burden
• Increasing
debt burden
• Volatility
of earnings
• Volatility
of earnings
Lower
credit rating
• Lower•credit
rating
• Increasing
costs
over time
• Increasing
funding funding
costs over
time
• Financial
and bankruptcies
• Financial
distress distress
and bankruptcies
• Onshore
• Onshore
foreign exchange
foreign exchange
rates (central
rates bank
(central
or bank or
commercial
commercial
rates) or rates)
offshore
or offshore
foreign exchange
foreign exchange
rates
rates
(set by FMO
(set with
by FMO
its counterparty
with its counterparty
bank offshore)
bank offshore)
used
used
for loan booking
for loan booking
• Disbursement
• Disbursement
in local currency,
in local currency,
USD or EUR
USD or EUR
• Interest
• and
Interest
principal
and principal
paymentspayments
in local currency,
in local currency,
USD or EUR
USD(based
or EURon
(based
a fixed
onlocal
a fixed
currency
local currency
amount) amount)
WHAT DOES
WHATITDOES
COST?
IT COST?
There areThere
costsare
involved
costs involved
in buyinginprotection
buying protection
against against
currency currency
movements.
movements.
FMO mayFMO
enter
may
into
enter
a hedge
into a hedge
against the
against
potential
the potential
losses, and
losses,
all costs
and to
all FMO
costs of
to FMO of
obtainingobtaining
(and, if necessary,
(and, if necessary,
unwinding)
unwinding)
the hedge
the hedge
from thefrom
market,
the plus
market,
other
plus
funding
other costs
funding
andcosts
the and the
agreed credit
agreed
margin,
credit will
margin,
be charged
will be charged
to the borrower.
to the borrower.
prepayment
can all create
can alladditional
create additional
costs to costs
you to you
ominal Nominal
interest rates
interest
for rates
local for
currency
local currency
financingfinancing
may
may prepayment
depending
on market
on developments
market developments
following
following
loan
loan
ppear more
appear
expensive
more expensive
than for than
hard for
currency
hard currency
financingfinancingdepending
disbursement.
.g., USD
(e.g.,
Libor+4%=USD
USD Libor+4%=USD
5% vs. LCY
5%T-bill+5%=
vs. LCY T-bill+5%=
15%). 15%).disbursement.
(1)
(1)
owever,However,
interest rates
interest
in different
rates in different
economies
economies
cannot cannot
e directly
becompared.
directly compared.
Higher nominal
Higher nominal
interest rates
interest
in rates in All aspects
Allshould
aspectsbe
should
considered
be considered
against your
against
resilience
your resilience
mergingemerging
market economies
market economies
result from
result
higher
frominflatiohigher inflatio- to exchange
to exchange
rate volatility,
rate volatility,
currency currency
devaluation
devaluation
trends, trends,
ary environments
nary environments
and/or expected
and/or expected
devaluation
devaluation
trends. trends. and inflation
and inflation
in your specific
in youroperating
specific operating
environment.
environment.
owever,However,
if the currency
if the currency
maintainsmaintains
a devaluation
a devaluation
trend, trend,
gher local
higher
currency
local currency
debt servicing
debt servicing
in the initial
in the
years
initial years IN COMING
IN COMING
TO A DECISION,
TO A DECISION,
IT IS KEY
IT TO
IS KEY
WEIGH
TO WEIGH
hould be
should
compensated
be compensated
for by lower
for by
debt
lower
servicing
debt servicing
in
in SUCH CONSIDERATIONS
SUCH CONSIDERATIONS
AGAINST
AGAINST
POTENTIAL
POTENTIAL
BENEFITS:
BENEFITS:
ter years.
later years.
• Borrowings
• Borrowings
and earnings
and earnings
are matched
are matched
as protection
as protection
MAKING
MAKING
AN INFORMED
AN INFORMED
DECISION
DECISION
against shocks
against shocks
ocal currency
Local currency
financingfinancing
is a way of
is aconverting
way of converting
one formone form• Less volatility
• Less volatility
in earnings
in earnings
f risk into
of a
risk
possibly
into a more
possibly
acceptable
more acceptable
form: specifically,
form: specifically,• Positive
• long-term
Positive long-term
effect oneffect
crediton
profile,
credit profile,
xposingexposing
you to a you
fixedtoforeign
a fixedexchange
foreign exchange
rate rather
rate rather
leverage leverage
potentialpotential
and overall
andcost
overall
of funding
cost of funding
han to currency
than to currency
fluctuations.
fluctuations.
Key issues
Key
to issues
consider
to consider
ere include
herewhether
include whether
your business
your business
can survive
canforeign
survive foreign Always consult
Alwaysyour
consult
FMO
your
investment
FMO investment
officer toofficer
see to see
xchangeexchange
volatility,volatility,
based onbased
your revenues
on your revenues
and balance
and balanceif local currency
if local currency
finance suits
finance
yoursuits
particular
your particular
needs. needs.
heet, and
sheet,
the loan’s
and the
proportion
loan’s proportion
of your total
of your
loans.
total loans.
(1) FMO contracts
(1) FMO
hedge
contracts
agreements
hedge agreements
with swap counterparties
with swap counterparties
which provide
which provide
FMO with assurance
FMO withofassurance
notional amounts
of notional
of amounts
its loan receivables
of its loan in
receivables
hard
in hard
currency, while
currency,
clientswhile
have clients
knownhave
notional
known
amounts
notional
of amounts
loan payables
of loan
in payables in
ocal currency
local currency
financing
financing
costs, and
costs,
any and
legalany
and
legal and
local currency.
local
Deviations
currency.from
Deviations
loan payment
from loan
schedules
paymentmight
schedules
require
might
FMOrequire
to
FMO to
(partly) unwind
(partly)
and/or
unwind
replace
and/or
hedges
replace
based
hedges
on then
based
prevailing
on thenmarket
prevailing
rates.
market rates.
perational
operational
implications.
implications.
For example,
For example,
missed or
missed
late or lateDepending on
Depending
the development
on the development
of market rates,
of market
replacement
rates, replacement
and/or
and/or
unwinding
resultmight
in FMO
result
incurring
in FMO
losses
incurring
that itlosses
charges
thaton
it to
charges on to
ayments,
payments,
changeschanges
to the repayment
to the repayment
scheduleschedule
after
after unwinding might
borrowers. borrowers.
is veryItimportant
is very important
that youthat
alsoyou
takealso
account
take account
of
of
isbursement,
disbursement,
provisioning
provisioning
(if you are
(if you
in default)
are in default)
and
and
LOCAL LOCAL
CURRENCY
CURRENCY
LOAN LOAN
VS VS
LOWER COST
LOWER
OFCOST
FUNDING
OF FUNDING
OVER TIME
OVER TIME
BETTER CREDIT
BETTER RATING
CREDIT RATING
HIGHER LEVERAGE
HIGHER LEVERAGE
POSSIBILITIES
POSSIBILITIES
FOREIGN
FOREIGN
CURRENCY
CURRENCY
LOAN LOAN
ENHANCED
ENHANCED
CREDIT PROFILE
CREDIT PROFILE
VOLATILITY
HIGH VOLATILITY
ON EARNINGS
ON EARNINGS
DUE TO CURRENCY
DUE TO CURRENCY
MOVEMENTS
MOVEMENTS
FULLY EXPOSED
FULLY EXPOSED
TO DEVALUATIONS
TO DEVALUATIONS
AND SHOCKS
AND SHOCKS
STABLE EARNINGS
STABLE EARNINGS
REDUCED
REDUCED
EXPOSURE
EXPOSURE
TO CURRENCY
TO CURRENCY
MOVEMENTS
MOVEMENTS
DEPRECIATION
DEPRECIATION
INCREASES
INCREASES
USD DEBT
USD
IN LCY
DEBTTERMS
IN LCY TERMSHIGH INFLATION
HIGH INFLATION
ERODES DEBT
ERODES
-> DEBT
LOW REAL
-> LOW
INTEREST
REAL INTEREST
RATES RATES
OW NOMINAL
LOW NOMINAL
INTERESTINTEREST
RATES eg.
RATES
LIBOReg.
+ LIBOR
4%=>5%
+ 4%=>5%HIGH NOMINAL
HIGH NOMINAL
INTERESTINTEREST
RATES eg.
RATES
T-BILLeg.
+ T-BILL
5%=>15%
+ 5%=>15%
“VISION BANCO FOCUSES MAINLY ON MICROFINANCE, ESPECIALLY FOR MICROENTERPRISES. THIS SEGMENT’S FUNDING IS PREDOMINANTLY IN GUARANI, WHICH
AVOIDS EXPOSING CUSTOMERS TO CURRENCY RISK, AS ALL ACTIVITIES ARE IN GUARANI.”
Beltran Macchi, President
CASE STUDY – VISION BANCO
CASH FLOW
Vision Banco, Paraguay’s largest microfinance bank,
The loan was disbursed in USD and converted onshore to
contracted a USD 10 million loan with FMO. The loan’s
PYG via Vision Banco’s partnership bank, enabling Vision
tenor is four years covering the expansion of Vision
Banco to use highly competitive onshore exchange rates
Banco’s micro and SME portfolio. Half the USD 10 million
compared to offshore commercial market exchange rates.
loan is in local currency (Paraguayan Guarani - PYG).
The loan is carried in local PYG, the calculation of Vision
Banco’s interest and principal repayments is based on the
AMOUNT
USD 5 million equivalent in PYG
PYG notional amount, while installments and interest are
TENOR
4 years
settled in USD.
LOAN BOOKING
in PYG
LOAN DISBURSEMENT
in USD
INTEREST PAYMENT
in USD
PRINCIPAL REPAYMENT
in USD
USD LOANS
PROCEEDS
USD PAYMENT
DUE
VISION BANCO’S
ONSHORE
RELATIONSHIP BANK
PYG LOAN
EQUIVALENT
Important Note: This document is for introductory purposes only and does not
constitute comprehensive advice on local currency financing. Local currency
financing may be subject to risks not described in this document. Any local
PYG PAYMENT
FOR USD PURCHASE
FMO
P.O. Box 93060
currency financing you enter into with FMO will be solely on the terms described
2509 AB The Hague - NL
in your specific agreement with FMO, which could be materially different to the
www.fmo.nl - info@fmo.nl
terms described above. This document is not a representation of the terms on
which local currency financing can, or will be provided, and should not be used to
interpret any local currency financing contract which you enter into with FMO.
Published July 2012