According to CII, micro, small and medium enterprises (MSMEs) contribute over 45 % of India?s industrial production and around 40 % of the total exports. With a total market size of $140 billion and providing employment to over 31 million people, the importance of the sector to the country?s economy can?t be understated. With $33,927.8 million coming from exports in 2005-06, MSME sector was exposed to the risk of about $1,215.3 million at the then annualised volatility level of 3.58% as witnessed in the RBI reference rate (currently estimated at 11.7%). Such a high volatility in currency movements has the potential to wipe out the profits out of earnings or add to their costs to the extent of about 12% making their businesses vulnerable.
When it is said ?unless such risks are appropriately hedged?, it is meant that they are hedged at costs that are equally applicable across the market participants irrespective of their size (buy/sell) and size of participation in a more transparent manner that would enable them to take swift decisions gauging the market movements and the expected payments at a convenient leverage. These were exactly the differentiating factors that made their participation in OTC forward markets ineffective. Due to their sheer size of forward requirements and the frequency at which they approach OTC markets, the quotes offered to them come at a considerable premium of 5-10 basis points for which the payment is made in advance.
A clear forex hedging policy is a must for SMEs with currency to achieve the desired risk mitigation objective in the futures markets. Such a policy should include future projected receipts in foreign currency and their cost of operations so that cost of hedging shall be maintained lower than the benefits to make it a meaningful process.
With access to commodity price risk management for the last few years, currency derivative markets would add another feather in the cap of the economy in terms of making it a lot easier and cost effective for SMEs to access currency markets on terms at par with their counterparts.
The author is chief economist, MCX. These are his personal views