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The more than 20 per cent depreciation in the rupee against the dollar over the last year would have dented the finances of importers who did not hedge their currency exposure. A steep appreciation in the rupee, on the other hand, can put exporters at a disadvantage.
Dealing with currency risk, especially in markets as volatile as present, poses a significant challenge to entrepreneurs. They should consider hedging their forex risk and focus on their core activities. Big businesses usually hedge currency exposures through their bankers in the over-the-counter (OTC) market. Given their size, they are in a position to negotiate rates with the banks and get good deals. But small and medium enterprises (SMEs) have often found themselves short-changed by the lack of transparency and high costs in the OTC market. Many SMEs were also sold exotic currency products in the OTC market, which caused them huge losses during the financial crisis of 2008-2009.
Good avenue for SMEs
In this context, currency derivatives traded on the recognised exchanges such as NSE and MCX-SX provide a good avenue for small and medium enterprises to hedge their forex risk. There are many benefits to SMEs from using the exchange route — standardised contracts on futures and options, transparency, and no settlement risk. The size of a USD-INR contract is USD 1,000, and the flexibility to trade even a single contract provides a lot of flexibility to the small entrepreneur.
On the flipside, liquidity on the exchange traded currency derivatives market, while adequate for the first one or two months, is quite low thereafter.
This could pose a problem for businesses that want to hedge their forex exposures over a longer period.
They would need to rollover and carry forward their contracts at regular intervals. But this would entail additional cost. Also, liquidity is quite low in contracts other than in the USD-INR pair. Improved liquidity on the exchanges would improve their hedging usefulness for businesses.
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