What Is a Hard Loan?
Let me explain what a hard loan is: it's a foreign loan that you, as a borrower, must repay in hard currency, which comes from a nation with political stability and strong economic reputation. For instance, if you're in a developing country, you might take out a hard loan in U.S. dollars.
Key Takeaways
- A hard loan happens when a foreign borrower gets a loan in a hard currency, like the U.S. dollar as a reserve currency.
- These loans are common for borrowers in developing countries because loans in unstable currencies are risky for lenders.
- If the borrower's currency devalues, it makes repaying the hard loan more expensive due to volatility.
How a Hard Loan Works
A hard loan involves a lender and borrower from different countries, with the loan denominated in hard currency. Hard currency is a globally accepted monetary system or reserve currency from a country with solid economic and political standing—it might not even be the currency of the borrower or lender. This setup greatly reduces risks compared to using less stable currencies.
There are risks involved, though. If your home currency drops sharply against the hard currency, repaying the loan becomes much harder. Take a Brazilian manufacturer borrowing in euros: if the euro strengthens 20% against the real during the loan term, it effectively hikes the interest rate and principal by 20%.
Forex Considerations on Hard Loans
What makes a currency 'hard'? It needs to stay relatively stable over short periods and be highly liquid in the forex market, where currencies are traded. The forex market is the world's largest and most liquid, handling trillions in daily trades and including every global currency.
Forex trades happen on spot or forward bases, over the counter, and around the clock without a central market. Major hubs include London, New York, Singapore, Tokyo, Frankfurt, Hong Kong, and Sydney.
For a currency to be hard, it must have stable value based on fundamentals like GDP and employment. The U.S. dollar's strength reflects America's top GDP of $21.43 trillion at the end of 2019. Even though China and India rank high in GDP, their yuan and rupee aren't hard currencies. Central bank policies and money supply stability also affect exchange rates. The U.S. dollar is the world's reserve currency, used in 88% of international trades.
Example of a Hard Loan
Consider a loan between a Brazilian company and an Argentine bank, repayable in U.S. dollars. This is a hard loan because the dollar is stable hard currency, more reliable than the Brazilian real or Argentine peso.
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