Ghana has had a somewhat liberal foreign exchange regime for decades. This has among other things allowed residents to freely transact in foreign currency, mostly the US Dollar (USD), for both international and local transactions. Indeed under our current foreign exchange regulations resident firms can contract either local or foreign currency denominated loans from banks regardless of currency of their revenues.

As a finance professional often involved in the structuring and negotiation of loans to corporates, I have witnessed an increasing number of businesses (and sometimes even individuals) in Ghana opting for USD denominated loans instead of the local currency loans. The key motivation has been that local currency interest rates are too high and cedi borrowings are therefore relatively expensive. This perception is widespread to the extent that even local currency earners with no USD revenues have insisted on borrowing in USD—a phenomenon described as currency mismatching, a form of wrong way risk. It turns out in fact that local currency loans over the medium to long term are cheaper than US Dollar denominated loans by as much as 70%.

Risk professionals who often advise against currency mismatching have usually argued that the practice creates (a) currency depreciation risks to local currency earners where such borrowers end up incurring foreign exchange losses if the local currency depreciates, and (b) foreign currency liquidity risk where local currency earners are not able to service USD debt obligations on time because of unavailability of physical USD currency for purchase—typically described as convertibility risk. For offshore lenders the additional risk that regulatory changes could restrict foreign currency transfers out of the country to meet debt service (currency transfer risk) often lingers although people have long argued that this risk in Ghana is relatively remote.

Theoretically, (covered) interest rate parity hypothesis predicts that it should not make any difference, returns (or cost)-wise, whether a business is investing (borrowing) in local or foreign currency. The end result should be the same in a reference currency—currency depreciation should exactly offset any difference in interest rates. However due to market inefficiencies that pertain in reality, we are far from a zero-arbitrage world.

It is interesting to note that even during the brief period of restriction on USD borrowing by the Bank of Ghana in 2014 and the resulting high cedi depreciation during that period, appetite for foreign currency debt remained high. Indeed some borrowers insisted on exploiting a window in the regulation which allowed foreign banks to still lend in USD to local entities regardless of the currency of their revenues.

Surprisingly, the notion that local currency debt is expensive has not really been interrogated empirically. If that is so, then the question is whether the notion is based on actual evidence or it is an exaggerated perception capable of defying palpable evidence? At least optically, interest rates and cost on cedi loans appear high compared to interest rates quoted for USD loans but the costs go beyond just interest service. Indeed many have argued that the view that cedi loans are expensive has not properly taken into account the persistent depreciation of the local currency, at least not in recent times.

Against this background, this article analyses the cost of local currency and USD debt over the last eight years, roughly since Ghana re-denominated its currency. The analysis compares equivalent amounts of USD and Ghana Cedi (“GHS”) debts priced for an “average” corporate (large SME) borrower in Ghana.

The main finding is that contrary to the perception of USD loans being cheaper, local currency debt has been shown to be cumulatively cheaper by up to nearly 35% for floating-rate borrowing and up to about 70% for fixed-rate borrowing for term loans with tenors between January 2008 and December 2015. The result is consistent across different time periods and loan pricing scenarios.

The rest of this article details the analysis comprising the assumptions for a hypothetical base case, the results and some key conclusions.

Summary of base case assumptions

In order to compare cost of borrowing in local currency to cost in foreign currency, I assume that in January 2008 two hypothetical firms contracted two loans each from a hypothetical bank in Ghana. One of the firms, the “LCY Borrower”, borrowed in local currency (the “LCY loan”) in both floating and fixed interest rates whiles the other firm, the “FCY Borrower”, borrowed the foreign currency equivalent amount in USD (the “FCY loan”) also under floating and fixed rates. The goal is to find out which of these two firms would have incurred higher total debt service (i.e. interest and principal payments) and under what type of interest arrangements (i.e. fixed or floating). The key terms of these hypothetical loan facilities are summarized in the Table 1 blow as Option I and Option II, together the Base Case.

Table 1: summary of key terms for hypothetical GHS and USD medium term loans

Option I: Floating-rate loans



Results

The results for the Base Case analysis are tabulated below and indicate that under a floating rate scenario the FCY Borrower would have paid a total amount of GHS26m to fully retire the floating rate loan, 35% higher than GHS19.4m paid by the LCY Borrower. On the other hand, debt service under the fixed rate loans shows that the FCY Borrower would have paid a total of GHS27.4m, compared to a total of GHS16.2m paid by the LCY borrower (68% higher for the FCY Borrower), to fully retire the loan.

Table 2: summary of key findings on total debt service



The interest service under the floating-rate FCY loan is 40% lower than that under the LCY loan. This observation shows the widely held perception that LCY interest costs are high, compared to FCY. However, interest cost is just one part of the story, as borrowers are obliged to repay capital as well. Indeed in some instances lenders are more concerned about the return of, rather than on, their capital. Table 2 shows that capital repayment under the FCY loan (in cedi terms) is much higher than that under the LCY loan by almost 110%. This makes the total debt service under the floating-rate FCY loan higher than the LCY loan by as much as 35%.

Similarly the total debt service under the fixed-rate FCY loan is 68% higher than the LCY loan. It is even higher than the over payments under the floating-rate loan. In this specific instance the fixed-rate resulted in lower interest payments under the LCY loan. Under the floating-rate the FCY loan “benefitted” from adverse movements in T-bill, which is absent under the fixed-rate scenario. Again the capital repayment contributed hugely to the higher payments under the FCY loan. Thus the devil is not in the interest but rather in the capital repayment.

Why these outcomes?

(1) Floating-rate loans



Fig. 1 shows trends in quarterly debt services split into interest and capital payments over the tenor while Fig. 2 displays these on cumulative basis. The irregular interest service curves reflect changes in outstanding exposures as well as changes in the respective base rates over time.

It is worthy of note that whereas the local currency capital instalment curve is linear and flat, that for the foreign is rather irregular and generally upward sloping, mirroring the effects of cedi depreciation against the USD (see Fig. 7 below).

Fig. 1 therefore shows that the cost of the USD loan (in cedi equivalent) comes mainly from capital repayments. The higher costs can be approximated by the area between the FCY capital repayment curve and that of the LCY capital repayment curve.

The increase in the amount of cedis required to meet the same USD capital instalment repayment – from an initial cedi equivalent of GHS305,625.00 in March 2008 to GHS1,185,937.50 in December 2015 – is 288% more than offsets any gains from the low USD interest service. Whereas the gap between FCY and LCY interest payment curves has narrowed over the tenor, that between the capital repayment curves has increased as the exchange rate increases.

On a cumulative basis total debt service for the FCY loan remained lower than the LCY loan debt service until about June 2013 under the floating-rate scenario and thereafter continues to be higher and increasing at a faster rate (see Fig 2). Again this latter trend reflects the rate of depreciation, which increased from 12% p.a. on average between Jan 2008 – June 2013 to an average of 24% between Jun 2013 and Dec 2015.

(2) Fixed-rate loan

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).

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 8-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. 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: 3, 5 and 6-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 2%. The pricing for the LCY loan would have been much higher given the 91-day T-bill rate of about 22.5% 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%.



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 amortized.

Effect of pricing (interest rates) on the relative costs of FCY and LCY loans 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 4% (or lower) over LIBOR while at the same time the LCY loan was priced at a margin of 16% (or higher). 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% 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% p.a. (i.e. average 3-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% 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

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 4% 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% in June 2008 the T-bill rate increased to almost 26% in September 2009, dropped to about 9% in September 2011 before rising up again to peak at about 23% in December 2012. 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% cheaper based on the Base Case pricing. Note that these periods of relative stability for the cedi are only deniable hindsight.

Trends in the key drivers: interest & exchange rates

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 4% 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% in June 2008 the T-bill rate increased to almost 26% in September 2009, dropped to about 9% in September 2011 before rising up again to peak at about 23% in December 2012. 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% cheaper based on the Base Case pricing. Note that these periods of relative stability for the cedi are only deniable hindsight.

Trends in the key drivers: interest & exchange rates

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 4% 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% in June 2008 the T-bill rate increased to almost 26% in September 2009, dropped to about 9% in September 2011 before rising up again to peak at about 23% in December 2012. 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% 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.

This analysis has been done on historical actual costs data and therefore the results and conclusions presented should be read and interpreted as “what would have happened” in the immediate past rather than “what is to happen” going forward.

This article does not purport to assert that history will repeat itself! Readers are left to take a view on future exchange and interest rates—issues outside the scope of this article.