India Inc Indifference To Hedging Impedes Profits, Value Creation Of Shareholders

Mumbai, October 27: | Updated: Oct 28 2002, 05:30am hrs
Uncertainty means risks. Rising uncertainties means more risks than ever before. This is true of all business entities, corporations exposed to the World Trade Organisations (WTO) new regime. But like it or not, unlike their counterparts in the developed world, more than 70 per cent members of the India Inc are exposed to the commodity, price and foreign exchange- (Forex) related risks and seem to be strangely enjoying the hangover of the protected economy.

Analysts here said, India Inc could be placed somewhere around 2.5 to three on a scale of 1-10 indicating a large section of India Inc and its bottomlines remains exposed to risks. So, by not hedging their risks in an increasingly choppy global environment, are Indian corporates meeting their twin responsibilities of maintaining and improving the bottomline and protecting stakeholders interests. No, said all connected with risk- management activities and even executives of number of corporates that FE spoke to.

According to an executive of a leading domestic private sector bank, the concept and the need of commodity derivatives and commodity hedging have not been fully appreciated by the top management of Indian corporate sector.

There has been both complacency and resistance from a cross section of Indian corporates in adopting hedging activities to safeguard themselves against unforeseen price risks, he added.

Thus, on the one hand, only a handful of corporates in just two sectors have understood the importance of hedging petrochemicals and non-ferrous metals, while, on the other hand, the vast segment of consumer durables, FMCG, agriproducts-related companies, cotton and man-made fibres and textiles companies and others are exposed to the rising risk levels and no one seems to be concerned much about this situation in an increasingly liberalised world.

A commodity futures trader at one of the leading foreign risk management entity said, Hedging, as a risk management concept, has just evolved in this country, but over the next few years, it would be inevitable for most of the companies to have in place risk-management desk.

Why Because in current times, maintaining and improving profits, and guarding and improving stakeholders value are both equally important. Without hedging through risk-management, this is not possible.

In the developed economies, it is almost imperative for companies to have hedging mechanism in place so as to protect stakeholders interest and the companys bottomline.

Not so in India. According to the Reserve Bank of India (RBI) only some 45 entities have sought clearance to hedge their import/export (Exim) positions on the international commodity exchanges. On the domestic front, majority of the corporates engaged in commodity business have preferred to stay away from hedging the various risks (especially in the agri commodities) even when there are over 22 commodity exchanges in the country and the government has permitted trading in futures of almost all agri commodities on these comexes.

An executive of a leading FMCG company requesting annonimity asked: Are our corporates really meeting stakeholders value Are they really creating value in their companies or are unconsciously engaged in value migration

By not hedging their risks, the Indian companies are exposed to the vagaries of price and commodity risks and accordingly neither protect the companys bottomline nor safeguard the interests of the stakeholders of the company, he said.

Precisely because of this situation the Federation of Indian Chambers of Commerce and Industry (Ficci), along with the ministry of consumer affairs, food and public distribution intends to look at the various related facets of commodity futures through a first-of-its-kind two-day conference on International Conference on Commodity Futures and Derivatives Trading: Indias Opportunities in the Emerging Global Context. The seminar will be held in Mumbai on October 30-31, 2002.

This would be one of the most important events that is expected to help the government and the concerned policy makers to chalk out the road map ahead for effective and successful risk management through commodity futures in the country. Speakers at the conference include Commodity Futures Trading Commission (CFTC) chairman James E Newsome; Lamon Rutten, coordinator, Commodity Trade, Risk Management and Finance, UNCTAD, Geneva; ICICI executive director, Dr Nachiket Mor; Dr Abhijit Sen; Dr RH Patil, chairman, Clearing Corporation of India and chairman Disinvestment Commission; National Stock Exchange (NSE) managing director Ravi Narain; Brian Lewin of the Wold Bank among others. Finance minister Jashwant Singh is expected to deliver the valedictory address.

Indian corporates are exposed to commodity price risk on their raw material and finished goods prices.

The wide fluctuation in the commodity price is putting tremendous pressure on the overall margins and on the profitability front.

Cost cutting measures may add up to the companys bottomline figures, but hedging actually helps to protect and even improve the bottomline, said an executive of a leading FMCG company. Because of our closed mindset towards hedging we do not know how much opportunities we are losing by not taking advantages offered by commodity futures, he said.

While it is lack of knowledge about hedging through commodity futures, it is also the lack of access to commodity exchanges both in the domestic and global. Global, because of the Indias fragmented international trade that allows only a few large corporates to take advantage of hedging allowed by the RBI since September 1998.

The trading volume of most of the corporates is not adequate to attract the interest of international commodity brokers to offer their hedging related services.

Except for top-rated corporates others are unable to even access international commodity exchanges due to size, creditworthiness etc. n the home front, the hedging facilities are available only in agri commodities on the 20-odd exchanges. It is no secret that for various known reasons these comexes have not been able to attract volumes and provide liquidity to large corporate players.

What is more, majority of the futures trade in agri sector is done in the parallel illegal trading platforms that thrive under the nose of the FMC, which industry sources said is a weak regulator that requires more focused strength from the government.

If the government can muster up resources financial and intellectual in the capital markets, why cant it do the same in the commodities market asked an executive of a leading agri products company.

Because of the success of the National Stock Exchange (NSE) in changing the face of Indias capital markets, the government now plans to set up a nationwide multi commodity exchange (NMCE) in the country. But a section of corporates engaged in agri-business and agri-trading community raise one vital question: What purpose would the NMCE serve if the government or the FMC have not been able to straighten the Comexes How would and wherefrom would the NMCE be able to attract the commodity futures traders who have migrated to the thriving illegal platforms

But if permitted, the banks would be able to provide substantial liquidity and support to the whole effort to reactivate the commodity futures in the country.

Unlike banks in the developed countries, banks here are barred from offering commodity derivative products. Once the domestic banks are allowed to offer corporates customised risk-management instruments to hedge commodity price risk, corporates would be able to do so by approaching domestic banks for Over the Counter Products.

Banks are, ideally, suitable to offer customised commodity risk-management solutions to the corporates to hedge their commodity price risk. Another important need is to have one national level commodity exchange for all commodities like precious metals, base metals and of course for soft/agri commodities offering efficient trading platform for standard derivative products. This would enable not only medium and small size corporates but more importantly farm producers, processors exporters and others effectively hedge their price risks. The fluctuations in the foreign exchange market have prompted the majority of the corporates to put in place the forex risk-management systems in place. However, in the new WTO-led world, even commodity and price-related risk-managment systems would be extremely important.But how effective would be the hedging and risk-managment activities in the global agri-mart where the US, the EU and Japan have been heavily subsidising their farm sector There is a growing disconnection between US agricultural futures markets and the real world of trade in grains and oilseeds, said Robert W Kohlmeyer, President Emeritus of World Perspectives Inc.