Volatile rupee: Policymakers, India Inc in a corner

| Updated on: Jul 21, 2013
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To minimise the impact of exchange rate fluctuations, companies should devise a comprehensive risk management policy.

The fluctuating rupee has depreciated significantly against major currencies. From approximately Rs 54 on March 31, 2013, the dollar value zoomed to approximately Rs 60 on June 30 — an above 10 per cent decline in the rupee’s value. For worried Indian companies with foreign currency exposure, the primary concern is to protect their profit-and-loss arising on foreign current assets/ liabilities. Exchange fluctuations pose several significant economic risks.

Transaction risk

It is the impact of exchange rate changes on the value of committed cash flows/ assets or liabilities recognised in financial statements, such as foreign currency loans, receivables and payables.

Under accounting standard AS-11, the exchange gain/ loss arising on restatement of foreign currency monetary items should be recognised immediately in the profit-and-loss. However, to address the concerns of Indian companies, the Ministry of Corporate Affairs amended AS-11 to give companies a one-time option in which they can defer/ capitalise the exchange differences arising on long-term foreign currency monetary items. This option has helped companies address immediate concerns over profit-and-loss fluctuation. However, capitalisation of significant exchange differences to fixed asset cost may raise impairment concerns. In either case, due to restatement at closing rate, the foreign exchange liability of the company in rupee terms increases. This may adversely affect the debt-equity ratio and create other business challenges related to compliance with debt covenants and raising new loans.

Economic risk

It is the impact of exchange rate fluctuations on the current value of uncertain/ uncommitted future cash flows. This will include, for example, impact on future revenues and expenses. Generally, rupee depreciation negatively impacts import-oriented companies as input cost increases. Many of these companies may not be able to raise the selling price due to competition.

For export-oriented entities, a decline in rupee value results in higher realisations. However, a customer may renegotiate rates and thereby neutralise the positive impact. It is also likely that after the rupee value increases at a later date, the customer may not increase the price.

From accounting perspective, an increase in input/ depreciation cost without a corresponding increase in selling price may mean that a previously profitable contract, particularly one involving thin margins, becomes onerous. Indian GAAP (Generally Accepted Accounting Principles) requires immediate provision for an onerous contract by charging total loss to profit-and-loss. In addition, shrinking margins may create impairment challenges.

Translation risk

This refers to the impact of exchange rate change on the financial statements of a foreign operation, such as a foreign subsidiary, included in the company’s consolidated financial statements (CFS). Under AS-11 the net impact arising on translation of non-integral foreign operation should be recognised in the foreign currency translation reserve (FCTR).

Still, any movement in exchange rate is likely to impact numbers in the CFS. To illustrate, assume that an Indian company’s US subsidiary has generated the same revenue (in dollars) as in the previous year. However, due to a decline in the rupee’s value, it will present significantly higher revenue in the current CFS.

Similarly, the US parent, while consolidating its Indian subsidiary, may end up presenting significantly lower revenue due to the exchange rate movement.

To manage/ minimise the impact of exchange rate fluctuations, a comprehensive risk management policy is needed, covering all the key risks.

While taking care to avoid knee-jerk reactions, companies should also provide adequate disclosures in the financial statements.

The author is Senior Professional in a member firm of EY Global

Published on July 21, 2013

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