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Volatile Re and the urge to hedge

| Updated on March 12, 2018

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Volatility in rupee in the last few months has created a lot of uncertainty in cash flows and the budgeting process. Companies will look for hedging and may be tempted to go for complex derivative products; however, it will be worthwhile to remember the lessons of 2008 when the outstanding derivatives position in India was almost five times the country's aggregate exim turnover.

In this connection, it is important to keep in mind the detailed RBI guidelines for derivative instruments and the requirement to get certificate from auditors on the outstanding derivative positions.

Companies may have to revisit their hedging strategies; the audit committee and the Board should ensure that the risk of hedging or not hedging the foreign currency exposure is understood and that the risk appetite of the company is well defined and adhered to by all.

IT bellwether's salary hike woes

Recently, an IT bellwether announced deferment of employee salary increments and stated it might revisit the decision in the middle of the year, based on market conditions.

One would recollect that in 2008 also, many IT companies had made a similar decision when the global economy and Indian economy were going through very difficult times. Does the current freeze again indicate a difficult time ahead for IT companies in particular, and Indian economy in general. The implications of this freeze on unemployment and growing resource pool could be significant. With regard to the global market situation, especially in Europe, will this salary freeze be restricted to IT or will it also spread to other industries, considering that the IIP growth in recent months has been minimal. The Indian economy may be facing a lot of headwinds, and we may need to tighten belts to fly though this period of uncertainty.

Changing fortunes of FCCBs

Between 2005 and 2010, Indian companies issued three- and five-year FCCBs worth $23 billion, of which $7.8 billion (at redemption value) will mature in 2012. Indian companies raised capital through the FCCB route owing to the low interest rates and the ability to convert the instruments into equity. But the present equity market situation and rupee depreciation against US dollar has created a challenge for Indian companies. Many bondholders are opting for redemption on maturity dates, resulting in heavy pressure on the companies' cash flows.

Interestingly, one of the large communication companies in India has entered into a deal with financial institutions to meet the entire redemption commitment of $1.18 billion. This is the largest FCCB refinancing deal that was filed with stock exchanges at the beginning of 2012.

So, what appeared to be an attractive instrument has seemingly become a cause of concern for many companies.

How will bankers see new disclosures?

In February 2011, the Ministry of Corporate Affairs notified and issued the Revised Schedule VI format, which would apply to companies uniformly for the financial statements to be prepared for the financial year commencing on or after April 1, 2011. This new format introduces several new concepts drawn from International Financial Reporting Standards (IFRS), including reclassification of assets and liabilities into current and non-current based on certain defined criteria.

Performance metrics based on commonly used ratios will be impacted on transition, and items considered current assets previously may become non-current. Similarly, previously non-current liabilities could now become current.

As a result, it is likely to impact the net current assets, current ratio and the company's drawing power based on working capital. Material breaches with loan covenants could result.

The big question is: how will the lending bank view these changes?

Perhaps, companies will need to re-negotiate covenants for the loans.

Published on April 29, 2012

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