Indian companies have accumulated $120 billion worth foreign currency debt. It is a fair bet that most of that amount has remained un-hedged against exchange rate fluctuations.

A couple of months ago, RBI Deputy Governor HR Khan expressed concern that the hedge ratio of outstanding forex loans and liabilities was just 15 per cent compared to about 35 per cent a year earlier.

Rising geo-political tensions and an increase in US interest rates a few months down the line are likely to turn the exchange rate more adverse. Says Param Sarma, forex expert and CEO of NSP Treasury Risk Management, “A number of hedge funds and FIIs may go out when interest rates rise in the US. 

“The rupee will be in for a testing time if US rates rise in a couple of months, even if RBI intervenes in the market.”

That situation is not unfamiliar. Indian companies have actually experienced this twice in recent memory — when the Indian unit dropped about 25 per cent against the dollar in 2011 and 2013. You would think people are wiser after that trauma and mitigated their risk by buying protection either from banks or from exchanges. Yet, strangely, that has not happened. 

Blame the regulator

If you ask market participants about this, they point to a number of reasons — including the absence of suitable products for hedging long-term exposures. But many say the RBI itself is responsible for the poor hedging levels.

There has been a prolonged spell of calm after September 2013, and the rupee has traded in a relatively narrow range of about ₹60-62.50 to the dollar, helped no doubt by RBI’s intensive and continuous intervention in the forex markets. 

The RBI’s official position is that it never has a target for the rupee and it will intervene only to smoothen volatility.  This has, however, allowed complacency to set in with the market having an erroneous belief that the central bank will come to their rescue if there is any adverse movement. That prevents any desire to hedge.

While experts agree that the central bank must provide a cushion in extraordinary situations to handle global turbulence, heavy intervention to keep the market boxed in a narrow range in normal times is probably contributing to the overall irresponsibility of the market, they say.

Long-term trajectory

The rupee’s long-term trajectory has usually been a long flat spell (range-bound movement) followed by a precipitous decline or disorderly moves in a narrow period.

Every now and then, the market is caught on the wrong foot when the currency movement turns adverse, but because of regulatory interventions, the dust settles and soon it is back to normal — and to complacency.

TB Kapali, forex consultant, says convincing his small and medium enterprise clients that they should buy protection is very difficult. Why, they ask, do we need protection when the currency is looking stable? Telling clients that this is not a permanent state of affairs is seen as scare mongering. 

As Kapali put it, there is no fear or even unease in the markets that currency movements can be two-way. Only if the markets move up and down and there is volatility on a continuing basis, will companies feel the need to hedge, he says.

That can happen only if policymakers create an environment that incentivises active risk management and hedging by companies.

One way for that to happen would be if the central bank keeps away from regular interference.  

Centre to the rescue

The Government’s willingness to amend accounting rules whenever corporate balance sheets are devastated has also contributed to the cavalier approach to hedging. When the fall in rupee in 2011 hit profits in the September 2011 quarter, there was an immediate outcry from affected companies.

The Ministry of Corporate Affairs came to their rescue by allowing companies to inflate the value of their asset (to correspond to the increased liability on account of exchange fluctuations) and then allowed them to provide depreciation on the inflated value — so that the losses are spread over a longer period instead of being recognised immediately.

Companies were given time till March 2020 to do this. Such of ad hoc reliefs are definitely a serious moral hazard, as companies no longer feel the need to behave responsibly and hedge their exposures.

Forward contracts

Market participants do have the option of locking into an exchange rate by buying forward contracts. But they come with one downside — that while you can eliminate potential losses, you also lose the opportunity of making potential profits.

Under present accounting rules, when forward contracts are booked, the final opportunity costs have to be recognised in the profit and loss statement.

Kapali says that this proves to be a powerful deterrent to hedging since finance managers fear they will be pulled up if the rate at maturity is different.

Here, the fundamental purpose of hedging (fixing a price) is lost to the hope of benefiting from probable market movements. If companies want to protect a price but still benefit from probable market movements, then they must do currency options. 

This is where education, awareness and training for corporate finance managers are critical. 

Poor awareness

 All these are often lacking. Companies not only display poor awareness but often betray a lack of working philosophy about taking risk cover. As one central bank official put it at a seminar some months ago, you can’t just punt and pray.

Even with tools such as currency options (meant to protect a price and also benefit the hedger in the event of a favourable exchange movement), companies are reluctant. Kapali says that the upfront premium to be paid for an options contract is often seen as a burden.

It may seem laughable that enterprises which are reputedly savvy should behave in a pennywise pound-foolish manner — but that is the reality. And this is true as much for exporters as for importers. 

 The treasury head of a large corporate put it rather succinctly. “Why is risk ignored?  Because it costs! But then, the cost is cheaper than the risk.” That truth is learned, more often than not, only by suffering. Those who wait to buy protection or insurance, do so at their peril.   

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