‘98% of companies do not have hedging cost budget’

The volatility in Indian rupee witnessed over the last two years drives home the need for hedging forex exposure. But Indian companies are remiss in doing that. Vikram Murarka, Chief Currency Strategist, Kshitij Consultancy Services, shares his view on hedging in the forex market.

What is the importance of hedging?

Hedging means offsetting or closing a pre-existing position you have in the market. For instance, an exporter, who is to receive dollar payments in the future, is inherently long dollars. When he hedges by selling dollar forwards, he is simply closing his long position. Similarly, an importer who buys dollar forwards is merely closing out his pre-existing short dollar position.

Hedging done at the right time and using appropriate tools can help exporters or importers enhance their profitability, with greater certainty and lesser volatility.

What are the instruments available for hedging?

The most commonly usedinstrument is the forward contract. Although it is inflexible, people use it because it is easy to understand and its outcome can be pre-known. The second tool is the Option, which is much more flexible but is used less since it is more complex to understand.

Different kinds of options can be combined in a number of ways (called exotics) to produce even more complex outcomes.

Other tools are currency swaps, interest swaps and caps and collars (in the realm of interest rate risk management). and Offsetting exports and imports against each other (the natural hedge) can also be called a hedging instrument. Futures contracts that are traded on the exchanges are but a specific form of Forwards only.

What is the cost of hedging?

The forward and options premium constitute the cost of hedging.  In India 98 per cent of the companies have never even explicitly thought about setting aside a hedging cost budget.

Companies should set a hedging cost budget to the tune of 3-4 per cent of their exposure without which the scope for 3.5-4.5 per cent gross profit through hedging cannot be achieved.

What prevents companies from hedging?

People have been numbed into saying “forex is not my business.” But, we challenge and emphasize that “forex is your business.”

Thesecond set of issues are lack of knowledge or belief that systematic hedging works or indecision as to what is the most optimal way to hedge. Creating awareness about hedging is a challenge, but that is what is exciting about it. The size of gross current account transactions is close to $800-900 billion per annum. If 0.5 per cent could be saved or gained through hedging, that would be $4-4.5 billion per annum. That is the potential we are talking about.

We aim to create this awareness by writing about it and through a series of “Forex IS your Business” workshops across the country. We had started with Kolkata. The next workshop is in Mumbai on June 12.

We also have a hedging solution in the form of the KSHITIJ Hedging Method, which has worked well over the last eight years.

Your quick view on the rupee…

The coming of the Modi Government has made the stock market bullish. Plus, the market is getting more confident that the RBI, under Raghuram Rajan, is keeping a firm watch on inflation. Thus, bond yields have turned lower. As both these markets can attract huge foreign capital inflows, it could lead to rupee strength in the medium to long term.

In the very near term, we could see rupee range between 58.65-59.65 or 58.25-60.25.