The Hindu Business Line : Forex hedging by IT companies

Hedging, for starters, is a strategy designed to minimise exposure to an unwanted business risk, while still allowing the business to profit from an investment activity, as Wikipedia defines.

Currency ‘volatility’ can destroy the margins. “When you convert all costs on the production side, and all sales receipts from the retail side, back into your home currency, you may be alarmed to find that your profits have diminished significantly, or disappeared altogether.”

Proactive hedging

For instance, Wipro reported on Thursday how revenues from global business grew in dollar terms but declined in rupee terms. This despite a hedging strategy formulated ‘to mitigate volatile exchange rate movements,’ as the company mentioned in its MDA (management discussion and analysis) for 2006-07. The strong rupee impacted Wipro’s operating profit margins by more than 3 per cent.

A case of success, though, was TCS. It spoke of a proactive hedging policy in its MDA.

“Net exposure is calculated for each currency by deducting expected costs from revenues in that currency.

The company hedges this net currency exposure using foreign exchange forward and options contracts. The tenure of these contracts is up to two years.”

At the end of last fiscal, TCS had a hedge position in various currencies “equivalent to $1,434 million compared with $566 million as on March 31, 2006.”

In fiscal 2007, the company booked an exchange gain of Rs 56 crore, “compared with a loss of Rs 69 crore (included in operating and other expenses in fiscal 2006).”

Infosys too speaks of ‘proactively hedging forex denominated receivables’. As of March 31, 2007, it had “$179 million (Rs 770 crore) of forward contracts and $269 million (Rs 1,158 crore) of options contracts outstanding.”

Transaction and translation losses amounted to Rs 21 crore, compared with a loss of Rs 8 crore in fiscal 2006.

However, forward and option contracts gains were Rs 63 crore, as against Rs 69 crore losses the previous year.

Net contribution of exchange differences to ‘other income’ was Rs 42 crore.