Taking cover

There is a timeliness to the concern expressed by the Reserve Bank of India’s Deputy Governor, HR Khan, about the declining hedge ratio of Indian corporates. The relative calm experienced by the forex markets in recent times appears to have lulled companies into complacency. According to the RBI, forex hedges have progressively declined from about 34 per cent of External Commercial Borrowings a little over a year ago to around 15 per cent recently. Corporates that do not hedge would have been badly affected by the 19 per cent drop in the rupee vis-à-vis the dollar last year. Given the difficult conditions in which most companies currently operate, a similar slide could be seriously damaging. Although such spells of high volatility are rare, they happen often enough to warrant protection against this risk.

Even so, companies often leave themselves exposed to market vagaries. Most seem to regard hedging as an unnecessary and avoidable expense, much in the manner of those who believe that premiums paid on life insurance have gone waste. This short-sighted approach persists, despite many burning their hands routinely due to currency fluctuations — finding that they either have to pay more than they had budgeted for or receive less than they had hoped for. Many cite the additional cost incurred on hedging as a reason to avoid it. The RBI’s mantra — that its job is not to defend a particular level of the rupee but to prevent undue volatility — is partly responsible for this behaviour. The markets interpret this as meaning that the rupee will be stable, until proven otherwise. The issue goes beyond some companies taking unnecessary risks. When such behaviour is pervasive, it threatens the very stability of the financial system every time the direction of the currency changes.

The RBI has tried moral suasion, flagging the issue with banks and emitting a disapproving growl every now and then. But banks have been unable to get a grip on this problem because the level of unhedged exposures of corporates is not clear. In the absence of any disclosure requirements on such exposures in the books of accounts, neither banks nor their regulator can do much. Perhaps it is time for the Centre to be seized of this important issue and make the necessary disclosures mandatory by appropriate changes in the regulations. Many small businesses are reluctant to approach banks since they have lost heavily on complex forex hedges sold to them by banks in the past. While such exotic options have been banned, the inter-bank forex market continues to be quite opaque, leading to higher hedging charges being levied on smaller businesses. Reviving the exchange-traded futures market, which is more transparent and suitable to smaller businesses, is another way of coaxing companies to protect themselves against forex fluctuations.

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