The editorial “Hedging habit” ( Business Line , November 2, 2012) is an analysis of forex rate movements and the desirability of hedging future liability to escape from unexpected rate fluctuations. Forex rates, especially US dollar/rupee rates, are currently experiencing rate volatility.

The central bank has opined that the forex rates are determined by the demand and supply of that particular currency. Why should a corporate hedge its forex future exposure, be it a purchase or sale? Hedging is a cover to limit the loss on forex exposure. Intra day rate fluctuations at times move up to one rupee per dollar.

The RBI directive highlighted in the editorial pertains to charging of higher risk premiums on loans made to corporates which have not hedged their forex exposure. But the compulsion to hedge may not be justified under regular rate fluctuations.

There is no basis to believe that the rupee appreciated because of its strength, thanks to the falling purchasing power of the rupee due to high domestic inflation. An exporter who has priced his export product in US dollar for delivery in next six months has to pay a higher cost for his inventories because domestic inflation is close to 10 per cent.

Suppose the rupee appreciates further by Rs 2 in the next six months. The exporter will be at a net loss of 10-20 per cent on his receivables. Suppose the exporter hedges his receivables based on present forex market movement, he has to pay a premium on his exposure with a marginal gain on the present rupee/foreign currency rate if the rate remains stable -- but will definitely make a loss if the rupee depreciates. Similarly an importer who has a forex liability payment after six months may hesitate to take a six months forward cover, since the rupee is appreciating.

The opinion expressed in the editorial that the hedging option be made flexible to suit varying conditions is apt in the context of current forex movements.

M. G. Warrier