How Cross-Currency Swaps Could Support Debt Refinancing Between Countries

Summary

The document outlines a theoretical way one country could fund another country’s borrowing at a lower apparent rate. An intermediary country could borrow in its own currency at a low rate, lend to the borrower at a somewhat higher rate, and use a cross-currency basis swap to hedge exchange-rate exposure. The margin would need to cover hedging costs, while the borrower would still bear its own credit risk under the loan.

The central limitation is scale: as the intermediary accumulates exposure to the borrower’s credit, markets may price that risk into its funding and lending terms, eroding the spread. The response therefore treats this as technically possible but unlikely to create a durable cheap-financing channel absent geopolitical motives. It gives a hypothetical rate illustration, not evidence that such an arrangement has been executed or that it would lower a country’s total borrowing costs in practice.

Key ideas

• A lower-rate sovereign borrower could theoretically lend funds onward and hedge currency risk with a cross-currency basis swap.
• The intermediary’s potential return is the lending and borrowing rate spread after hedging costs.
• Large-scale lending would increase the intermediary’s exposure to the recipient’s credit risk.
• Credit exposure and market pricing could eliminate the apparent funding advantage.
• The arrangement is presented as a theoretical possibility, with geopolitical motives suggested as a reason it might persist.

Tags

# can a country replace its debt with a low interest loan?


# can a country replace its debt with a low interest loan?












Recently in my country, someone started a buzz in which he had plans to replace current debt of the country with low interest loans from other countries such as Japan. May I know if this is possible at all ?

## Answer by cpage (score 2)

https://quant.stackexchange.com/a/42763

Suppose Country XYZ can borrow at 5% in XYZ currency and Japan can borrow 1% in JPY. Theoretically, Japan could borrow JPY at 1%, lend it at 1.5% to Country XYZ, and hedge the currency risk using a cross-currency basis swap. This is theoretically possible and Japan could profit on the 50bps (minus hedging costs) spread between its lending and borrowing rate.

Were this to happen on a large scale, however, the markets would catch on since the credit risk of Japan would become more and more exposed to the credit risk of Country XYZ. If this exposure grew to be large enough, you would expect any possible spread for Japan to make from acting as the middle man to go away.

This is debt-replacement strategy is possible, but definitely seems unlikely unless there are other geopolitical reasons why the middle country (Japan in this case) would want to lend money to Country XYZ.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.