But why would a corporate that has, presumably, gone abroad in search of cheaper capital deliberately exchange these borrowings for more expensive rupee finance? Well, apart from not having to worry about the exchange rate risks at all, it can leverage its competitive advantage in the foreign exchange markets to shave off points from the domestic prime lending rates (PLRs).

CFOs need not only consider rupee-dollar swaps; cross-currency swaps are a neat method of creating natural hedges. For instance, suppose a firm's exports are denominated in yen, but its ECBs are dollar-denominated. Then, the CFO can swap his dollar obligations for yen obligations, and hedge the latter through his export earnings.

SECURED EXCHANGEABLE BONDS. A currency swap shifts the foreign exchange risk to a counter-party; a secured exchangeable bond shifts the currency risk to the investor by adding a currency swap option to the basic Euro-bond. For the investor, the option to convert Euro-bonds to rupee debt that offers rupee rates of interest will be in the money if the interest rate differential outweighs the risk of currency depreciation. Such a conversion will, no doubt, hike interest costs, but it eliminates the foreign exchange risk.

Offering the option can also lower the initial coupon rate. For example, Morgan Stanley used this instrument to raise over $200 million for an Indonesian company at a phenomenally-low coupon rate of 2 per cent last year. For some obscure reason, the regulations now ban Indian companies from adding such swap options to their Euro-bond issues even though conversion could result in a lower net foreign exchange outgo. A move towards full convertibility, however, should remove such anomalies.

The CFO's Need:
Ensuring That Interest Rate Volatility Does Not Cause Financing Costs To Balloon

For the investor, the interest rate risk is the impact on his investment due to a change in the interest rate. For the CFO, the interest rate risk is the impact on his cost of financing due to a change in the interest rate. Obviously, liberalisation, which has been predicated on interest rate rationalisation and decontrol, will magnify that risk. Examine the sharp jump in volatility it has already unleashed: in the decade between 1980 and 1989, PLRs remained stuck at 14 per cent; in 1996-97, PLRs moved rapidly, changing three times in a single year.

But deregulation has not just splayed jagged spikes all over the PLR graphs; it has also increased the CFO's vulnerability to volatility. For, a larger proportion of lending will now be at variable rates. Since most ECBs are pegged to the LIBOR, the rising share of such borrowings has led to floating interest rates. Expect the domestic term-lending institutions to include provisions for interest rate changes while extending long-term loans. And, as the working capital paradigms change, CFOs will have to cope with rate changes even within the short span of the working capital cycle.

No doubt a gamut of products, and free-floating rates, give the CFO tremendous flexibility to create a financing mix that yields the lowest possible cost. But if that low-cost mix does not provide for volatility, a sudden upward spike in interest rates will throw financing cycles out of gear. Cautions Citibank's Anil Jaggia: "Corporates have to design buffers to ensure that interest rate volatility does not translate into earnings volatility. Otherwise price-earnings (P/E) ratios will drop, compounding financing problems."

The Natural Hedges

VARIABLE RATE FUNDING. In a market economy, the interest rate cycle is closely linked to the business cycle. An economy slipping into a recession will, typically, witness a falling interest rate graph whereas an upturn rides up that graph. CFOs can compress the downside of this cycle without necessarily sacrificing the upside of lower interest rates through the careful calibration of the quantum of floating rate funds in the financing mix.

Advises United Phosphorus' Desai: "In a situation of easing liquidity, like the one that prevails today, it is best to lock on to the low rates through fixed rate loans before the recovery gains momentum, and pushes up rates." Conversely, if the liquidity spigot runs dry, as it did in 1995-96, floating rate financing is the optimal strategy.

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