Everything you need to know about local currency financing.

All around the world developing countries need access to fair and affordable finance to build strong economies and financial markets. Continue reading to learn about local currency finance, why it is essential for financial market development and how lenders can use it to protect local businesses and people against financial risks.

What is local currency finance?

Local currency financing is the practice of issuing long-term debt in the currency of the borrower`s income and helps buisnesses to avoid currency mismatches. It allows the borrower to service their debts stably in the event of depreciation and avoid bankruptcy.

Why local currency finance?

Historically, businesses in developing countries rarely have access to loans denominated in their own currency. The loans offered to them in international markets are usually issued in hard currency such as USD or EUR. This leaves borrowers exposed to foreign exchange (FX) risk. For example, if their own currency depreciates due to financial shocks, borrowers may no longer be able to service their debts. This happens because their currency depreciates far below the value of the hard currency loan issued. Providing loans in the currency of the borrower protects businesses and people against financial risks and creates security against future financial shocks.

Local currency financing reaches users the base of the pyramid

The nature of local currency financing reaches far beyond businesses, to users at the Base of the Pyramid (BoP). For example, if debt is issued in local currency to a utility company, tariffs can be kept at manageable rates for their customers because the business does not service the debt in USD or EUR and is thus, not exposed to currency volatility. This provides more local people with access to essential services at a fair cost.

How are local currency loans issued?

Local currency loans or swaps are made available through the existence of the derivatives or swap market. Financial players come together in these marketplaces and make an agreement between two parties to exchange terms and/or interest payments of a loan in one currency for an equivalent loan in another currency.

What kinds of local currency instruments do Cardano Development companies use?

There are a range of local currency financing instruments available to raise debt finance. Local currency instruments function well in blended finance transactions and work to manage the risk associated with foreign debt transactions. Cardano Development companies specialise in the following two local currency financing instruments.

Guarantees

CD group company GuarantCo offers guarantees for development projects. Guarantees denominated in the borrowers own currency can be used to enable direct lending from local banks/financial institutions or capital market issuances.

Hedging currency swaps

CD group company TCX Fund enables loans in local currency by heding currency swaps. They hedge risks through the currency swap market where financial players come together to agree on cross-currency swaps or forward contracts .

What are the risks of hard currency loans?

Hard currency loans offered in international markets leaves borrowers exposed to (FX) and interest rate risks due to unexpected currency depreciation and global financial shocks. Over the years there have been significant currency crisis events that severely impacted economic prospects globally and on a regional basis.

What are the benefit of borrowing in local currency finance?

The benefits of borrowing in local currency, in comparison to hard currency, helps stakeholders in the local currency eco-system develop businesses, markets and infrastructure.

  • LCY stakeholders
  • Governments
  • National or Sovereign Companies
  • Financial Markets
  • Benefits
  • Governments in some emerging markets can finance themselves domestically or internationally through government bonds issued in local currency. This helps support government spending and obligations.
  • Local currency loans have long-term tenors and protect companies and projects against currency fluctuation. Borrowing in local currency from a bank can help the creditworthiness of a project, as the borrower can be measured on their ability to pay their debts based on their own currency without the risk of currency volatility.
  • The adoption of innovative local currency finance techniques helps to foster the overall development of financial markets. Resilient markets resist financial shocks, deal with global challenges and support growth. Once markets are developed, they can provide attractive investment opportunities and alternative sources of funding to financial markets across regions.
  • LCY stakeholders
  • Governments
  • Governments in some emerging markets can finance themselves domestically or internationally through government bonds issued in local currency. This helps support government spending and obligations.
  • National or Sovereign Companies
  • Local currency loans have long-term tenors and protect companies and projects against currency fluctuation. Borrowing in local currency from a bank can help the creditworthiness of a project, as the borrower can be measured on their ability to pay their debts based on their own currency without the risk of currency volatility.
  • Financial Markets
  • The adoption of innovative local currency finance techniques helps to foster the overall development of financial markets. Resilient markets resist financial shocks, deal with global challenges and support growth. Once markets are developed, they can provide attractive investment opportunities and alternative sources of funding to financial markets across regions.

What are the downsides to local currency financing?

Local currency loans require borrowers to pay higher amounts of interest at the initial stage of the transaction. Ultimately clients naturally dislike the high interest rates associated with LCY and have a cognitive bias in considering devaluation risk. At the same times, LCY does not seem appealing during the frequent period of high positive real interest rates and apparent currency stability, until the next crisis occurs unannounced. 

Low-income countries at a disadvantage with Local Currency Finance

Unlike some developed emerging markets, low-income countries (LICs) are at a disadvantage to sell their own local currency bonds (if any) to international investors. Therefore, LICs are limited in their ability to borrow internationally in their own currency. By issuing local currency bonds more capital is mobilised for local financial markets. This can only happen if there is sufficient legal, regulatory and compliance development in local capital markets.

How can we develop access to local currency finance?

Efficient and developed local capital markets create access to long-term, local currency finance, which predicates a well-functioning private sector that drives employment. Development banks and local currency financing innovators can create access for investors by supporting governments and regulators in developing countries to promote reforms and policies that support market development.

How is Cardano Development creating local currency finance solutions?

We believe that local currency finance for financial markets plays a vital role in economic development. Through our public and private investors, seed funding is made available to our start-ups, that have local currency and financial market development at the core of their business. Each of our start-ups and established businesses target a specific niche that increases access to affordable working capital for businesses and has a market shaping effect on the local financial markets.

Who offers local currency finance solutions?

  • Cardano Development
  • GuarantCo
  • TCX Fund

What are some successful examples of local currency financing?

This collection of case studies provides insight into some of the best local currency financing examples in the market.

Does local currency financing contribute to the UN Sustainable Development Goals?

By issuing finance in local currency borrowers can avoid (FX) risk which threatens the sustainability of SMEs, infrastructure, energy and environmental/climate projects. These sectors are key to achieving the UN Sustainable Development Goals (SDGs).

Would you like more information on local currency finance?

For your information we have compiled a list of detailed reports on local currency finance. If you would like to reach out to our team for further information, please contact [email protected].