A Potion Of Stable Rupee And Unhedged Exposures By Corporates Is Bubbling

Stability in the Indian rupee has turned corporates complacent, especially the mid-sized and smaller ones, resulting in large unhedged foreign currency exposures, according to people who spoke to NDTV Profit.

Large corporates have a risk management policy in place and, hence, are mandated to hedge their forex exposure.

But mid-sized and smaller corporates with an exposure of up to Rs 500 crore to foreign currency risk are keeping away from hedging, according to Abhilash Koikkara, head of forex and commodities at Nuvama Group.

"It is difficult to convince clients to hedge," Koikkara said.

Currency hedging is a strategy used to mitigate the risk arising from volatility in a currency pair. This strategy is aimed at protecting against losses if the exchange rate of the foreign currency changes unfavourably before a payment is made or received.

This low volatility in the spot rupee market comes from the aggressive two-sided intervention by the Reserve Bank of India in the local currency market in the last four months. Owing to this, the rupee has traded in a narrow range of Rs 83.25-83.40 a dollar for a while. On Wednesday, the local currency closed at Rs 83.04 against the dollar.

"While it's good to have a somewhat stable currency in an uncertain global environment, it's not a good idea to kill the volatility completely," said Dhiraj Nim, economist at ANZ Research. "Because then, not just the trading community but also the corporate community begin to assume there was no risk in the foreign currency transactions."

Hedging activity by corporates has weakened considerably in 2023. This could result in a large hit on the forex exposure of small exporters and importers in case of any sudden external shocks, Nim said.

India's net import bill for oil and gas, which accounts for more than half of the country's total imports, was $11.1 billion in November. This makes it crucial for importers to hedge their currency exposure to minimise the risk.

Typically, oil and gas companies enjoy a natural hedge on their import payables. This means that if the expenses are incurred in the US dollar from which their revenues are generated, they will naturally reduce their exchange rate risk exposure.

Let's look at an illustration to understand this better.

An oil and gas company has purchased crude oil worth $500 million at Rs 83 a dollar, and the payment needs to be made 30 days or 60 days later from the date of the bill of lading. In case the rupee depreciates to Rs 83.10 in the future, its inventory will be valued higher.

On the other side, the liability of the oil company to its foreign supplier will also increase as the cost of purchasing crude oil is higher. Hence, the revenues generated through higher-priced inventory will offset the increase in the value of the payment to be made to the supplier. To put it simply, the natural hedge strategies for currency risk include the matching of revenues and costs.

In the current scenario, the importers are entering into near-term dollar-rupee forward contracts, specifically from cash (same day) to 15-day or three-month contracts, a Treasury dealer at a public sector oil and gas company said, speaking anonymously. This is simply because the rupee is not expected to budge from current levels, he said.

In the current scenario, most corporates have stop-losses at Rs 82.90 on the appreciating side and Rs 83.40-83.50 on the depreciating side, according to people who spoke with NDTV Profit.

Exporters and importers will only think about hedging once the stop-losses on either side are breached.

"Till that time, they are okay with exotic options, hedging a bit here and there, and doing everything on (fair) value hedge and cash (flow hedge) basis," Koikkara said.

Most traders and experts expect the rupee to appreciate to Rs 82.50–82.80 a dollar in the coming months. But considering potential external risks for the dollar-rupee on either side, analysts believe it is prudent for corporates to hedge their forex exposure adequately.

Rupee will gain against the US dollar due to a combination of factors, according to analysts. These include the global weakness in the dollar, potential dollar inflows and expectations of the current political dispensation winning a third term in the Lok Sabha elections this year.

On the flip side, any flare-up in geopolitical tensions, risks from soaring public debt by governments across the world, and a rise in crude oil prices may weigh on the Indian currency.

For the oil and gas company treasurer mentioned above, its hedging strategy is dependent on a potential rise in the Indian currency, moving to Rs 82.80–83.00 a dollar. At these levels, they will look to hedge their import payables as well as external commercial borrowings maturing within 12 months through forwards.

This is based on the view that the RBI will restrict the rupee's appreciation around these levels, the person quoted above said.

Indian corporates that have borrowed in a foreign currency, say the US dollar or euro, are mandated by the RBI to hedge their exposure to currency volatility. For that, some larger companies with a robust risk management strategy are entering into exotic options structures, according to a currency dealer at a big private bank who spoke on condition of anonymity.

"The proportion of options for hedging by bigger corporates has gone up, for sure," Nuvama Group's Koikkara said. "Some companies are doing 60% options and 40% forwards. But at least they are not deviating from the hedge percentage as much as smaller corporates."

Corporates can hedge their currency exposure using several strategies: forward derivatives, futures derivatives, and options contracts. While forward derivative contracts require the payment of the agreed-upon price at a future date in exchange for the asset on or before a maturity date, option-based derivative contracts provide the holder with the option, but not the obligation, to exercise the contract.

Choosing the right mix of hedging tools depends on the risk and cost of hedging. The aim is to average out the hedging costs to minimal.

Interestingly, importers are not attracted to the historically low forward premium on the dollar-rupee of just 125 basis points, given no significant return on such swaps. For exporters too, the incentive to hedge has been negligible due to lower forward premiums and stability in the currency pair, the third person quoted above said.

Exporters are on the sidelines with some dabble in exotic options, which gives them the ability to protect a level instead of being stuck at a forward rate and suffering losses.

A shift in hedging through exotic options, which is also seen as a cost-saving strategy, has its own brewing troubles, the second person quoted above said.

Hedging through natural forwards is reaping no benefits for corporates. But exotic option structures, despite being a risky tool, save cost.

"In exotic options, the cost saving is 100% but the problem is it does not have a perfect payoff, because it can spiral out. So you have to be nimble on when to get out of it, when to add another structure. That’s why it is not easy," Koikkara added.

Analysts said that it is difficult to ascertain the extent of cost savings through exotic structures because it depends on individual corporate exposures, the kind of option structures, premium rates and so on.

Stability in the Indian currency has clearly led to a churn in the hedging behaviour by corporates. But, the consequential troubles are simmering, more so now than before.