The Hindu Business Line : Naturally edgy

Reliance Industries Ltd (RIL) perhaps would be one of the few Indian enterprises that would not mind India’s foreign currency transactions being predominantly designated in dollars because the debt service obligations emanating out of its foreign loans designated in greenback as well as those arising out of its import of crude can be easily paid off with the copious inflow of dollars it earns from exports of petroleum products.

Agony for others

The natural hedge that it enjoys could be the envy of the state-owned oil marketing companies like Indian Oil Corporation (IOC) which have to find dollars to pay for their imports while their revenue streams are in rupees .

Even if they buy crude in the futures market that in retrospect proves to be a good bargain, still they have to agonise over the foreign currency market where hedging is infinitely more difficult.

Indeed, IOC’s is an unenviable position what with it having to contend with two volatile markets — market for crude and market for foreign currencies.

The Surat diamond exporters may not be as happily placed as RIL because there is a huge and greater import content in their exports but the natural hedge that they enjoy would make them less edgy at the end of the day.

To be sure, there are other hedging strategies and instruments but all of them come for a price. Currency swap is hailed as the most effective and less expensive hedging strategy after natural hedge.

The World Bank tided over its foreign exchange crisis in 1981 with a mutually beneficial swap transaction with the computer major IBM that is even today talked about in awe tinged with envy in seminar circuits.

The US government in throes of a financial crisis has been lucky to get dollars from China sitting on a pile of foreign exchange reserves predominantly built in the US dollar once again through the currency swap mechanism.

Currency futures

But currency swap works and excites interest of international currency dealers only when the two currencies are floating.

The rupee is not yet a floating or freely tradable currency. That leaves currency futures as the only viable option if at all for those not having the natural hedge advantage.

In the absence of an exchange traded currency futures market, Indian residents were earlier driven to entering into forward contracts in the OTC market.

But now that both the NSE and the BSE are having rupee-dollar currency futures market, they can possibly have the satisfaction of hedging their risk in a more transparent and efficient manner to full or partial extent.

Both the trading platforms allow currency futures trading for durations of one to twelve months.

Besides, there is a cap on exposure at a given point of time — $25 million.

Serving importers’ interest

The twin restrictions thus may at best serve the interests of importers with a modest exposure in dollars at a given point of time. It may not be of much avail to IOC, for example, because of the huge size of its shipments.

And it won’t be of any avail to those who have mobilised funds on capital account through ECB or FCCB given the fact that the repayment of principal might be in the distant future, at any rate beyond twelve months and $25 million is a very small amount for capital account transactions.

Many companies which raised money through FCCB when the Indian bourses were on song, and thus did not in their wildest dreams reckon with the possibility the conversion option not being exercised by the foreign investors, are going through anxious moments because redemption pressure stares them in the face warranting greater quantum of rupee outflow than what was received in rupees at the time of mobilisation of funds.

Those who are rooting for full capital account convertibility of the rupee are doing so not only to enable the Indian currency to find its own level but also perhaps to enable Indian residents to partake of the benefits of currency swap.

Till this happens, those having liabilities denominated in foreign currencies are going to be naturally edgy unless of course they enjoy natural hedge — receipts in dollars sufficient to take care of the repayment obligations in dollars.

ECB option

ECB might still be cheaper in terms of interest but one resorting to it may have to keep his fingers crossed till he pays up the loan in full. What one saves on interest — which incidentally is not substantial now in the wake of the US and European financial markets meltdown — might well be lost in the form of greater quantum of rupees needed to buy a dollar at the time of payment of interest or principal if foreign currency exposure is left un-hedged or in the form of cost of hedging, if such exposure is indeed hedged.

So let us not be judgmental about those who do not hedge their exchange rate risks because naked exposure itself is a strategy often winsome and winning, though demonised by purists as an act of speculation.

This may be likened to self-insurance practised by airline companies which find it worthwhile not to insure their aircraft owing to the prohibitively high cost of insuring them. Given the volatile nature of the currency market, those betting on appreciation of the rupee stand as good a chance of winning their bets as those betting on the appreciation of the dollar.

This being the case, keeping one’s exchange rate fluctuation risk is an equally good strategy though at the end of the day everyone —edged as well as un-hedged — is going to have a sleepless night.

(The author is a Delhi-based chartered accountant. blfeedback@thehindu.co.in)

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