Firms across Asia are rushing to take out loans in foreign currencies while interest rates are low. By the end of October the value of these loans had jumped some 52% to 36 billion dollars. Some worry, however, that these foreign currency loans could pose systemic risks for financial systems across the region.

Foreign Currency Loans

Fed looking to continue quantitative easing

Asian companies are being drawn to the low interest loans being offered in US dollars and other currencies. With the United States Fed looking to continue quantitative easing in the near future, interest rates will likely remain low. Most loans being offered, however, feature floating interest rates, so rates could increase dramatically once the government eases off its Q.E. programs and looks to raise its benchmark interest rates.

More complicated still, when the United States does wind down its quantitative easing program, it could cause the value of the dollar to rise over time. As the United States continued to increase the money supply in order to increase liquidity, some analysts have concluded that the value of the dollar has been artificially suppressed. When the United States reverses course, the money supply will no longer be growing, which should increase the value of the dollar over the long haul.

The dollar could strengthen verse other currencies

If interest rates and the value of the dollar were to climb at the same time, foreign companies may find themselves hard pressed to repay their dollar denominated loans. Interest rates will rise, making the cost and burden of the loan much higher. Meanwhile, the dollar could strengthen versus other currencies, making it harder for foreign companies to repay dollar denominated loans with their local currencies.

A few analysts have even noted that this scenario is similar to the Asian Financial Crisis back in 1997, which brought many countries in Asia to their knees. A variety of circumstances led to this crisis, but the end result for most countries was quite similar. Confidence in local currencies plummeted as central banks were unable to defend their respective currencies. When this occurred, many companies suddenly found themselves struggling to pay off foreign denominated loans.

Now, there is a risk that companies could be caught in a similar scenario. Most central banks in Asia, however, are well-capitalized and the 36 billion dollars in outstanding loans will not be enough to threaten national economies. So an Asian fiscal emergency on par with the 1997 crisis is unlikely. That being said, individual companies could come under pressure if interest rates and the value of the dollar increase.

The loans themselves could pose little-to-no threat

This could curtail local economic growth and lead to some companies having to restructure their operations. Investment could also slow as conditions become more uncertain. On the other hand, if economic growth continues and companies are smart with their investments, the loans themselves could pose little-to-no threat. Either way, the situation is worth monitoring closely given how fragile the global economy is.