The major advantages that accrue from availing a foreign currency loan are lower interest rates and freedom from exchange risk. In raising a foreign currency loan, the prospective borrower should keep in mind that these advantages are not lost to him.
Firstly, the foreign currency loan is offered by the overseas banks only against the guarantee from bank in India. Therefore, the borrower should add the guarantee fee payable by him to his bank to the cost of raising the foreign currency loan. The Interest rate plus the guarantee commission should be cheaper than the local rate of interest.
Secondly, the exchange loss on conversion can be avoided provided the purpose for which the loan is raised is payable able in the currency of the loan and the source of repayment is also in the same currency. For instance, avoidance of exchange risk can be obtained if the loan is raised to import a machinery by paying in dollars and export proceeds of the merchandise of the borrower is also realised in dollars and adjusted towards the foreign currency loan.
The above two factors will help him decide whether to go in for foreign currency loan or not. If he decides in favour of foreign currency loan, the various aspects of the specific loan should be considered to make it most economical.
(i) The period of repayment of loan should synchronise with the cash accruals of the borrower. Loans for longer periods may be preferred, but in any case, the repayment cannot exceed 10 years.
(ii) The interest should be on a floating rate basis, rather than fixed throughout the period of loan. This will give him the leverage of benefiting from fall in interest rates.
(iii) Where the currency of loan and the currency of source of payment are not the same, the loan agreement may be made to include a currency option. Even otherwise, the currency option may give a chance to the borrower to take advantage of exchange rate movements.