What’s a hard loan?
Hard loans are international loans that require payment in a stable and economically strong nation’s currency. A developing country may borrow using a U.S. dollar hard loan.
How Hard Loans Work
A hard loan is a two-country, hard currency loan between a lender and a borrower. Hard money is a monetary system or reserve currency acknowledged globally for the payment of goods and services. It may not be the borrower’s or lender’s currency and originate from a powerful economic and political nation. Hard loans significantly minimize risk compared to loans in unstable currencies.
Some dangers remain. The borrower may struggle to repay the loan if their local currency plummets versus the hard currency. If a Brazilian manufacturer obtains a euro-denominated loan and the euro rises by 20%, the interest rate and principal amount will increase by 20%.
Forex Hard Loan Considerations
What makes a currency hard? Expect it to stay stable and liquid in the foreign exchange (FX) market. The currency market is the world’s largest and most liquid, trading trillions of dollars daily. The list contains all global currencies.
Forex transactions occur over-the-counter and 24/7, on a spot or forward basis. No central FX market exists. Financial centers, including London, New York, Singapore, Tokyo, Frankfurt, Hong Kong, and Sydney, have the most significant foreign currency markets.
The hard currency value must be steady. Currency values are primarily dependent on GDP and employment. The U.S. dollar’s global strength reflects America’s GDP, which was the world’s largest at $21.43 trillion in 2019. While China and India have the second- and fifth-ranked GDPs globally, neither the Chinese yuan nor the Indian rupee are considered hard currencies. This shows how central bank policy and money supply stability affect currency rates. Since it’s the world’s reserve currency, 88% of international trade uses the U.S. dollar.
Example of Hard Loan
A loan agreement between a Brazilian company and an Argentinean bank that pays in U.S. dollars is complex because U.S. dollars are more stable than the Brazilian real (BRL) or the Argentine peso.
Conclusion
- Foreign borrowers in hard currencies like the U.S. dollar have hard loans.
- Since lenders are wary of loans in unstable currencies, borrowers in developing countries typically take out hard loans.
- Devalued currencies make hard debt repayment more expensive.
