Running For Cover: A Question Of Billions

Updated: May 19 2003, 05:30am hrs
India Inc has always been open to dollars. But a recent kind of openness -- not hedging -- has caught the attention of the Reserve Bank of India (RBI). It has said that those with forex exposures will do well to cover. Before we go into as to why that should be the case, let us examine why it is not so.

Says Grasim Industries chief financial officer DD Rathi: "Corporates are not going in for a hedge as they want to double the benefits... first, in the hope that the rupee will appreciate and second, they do not want to pay a premium. As a consequence, they take an exchange rate risk. I personally feel it is prudent to hedge the risk to the extent required. That is because you can see your costs upfront." Adds Sterlite Industries director-finance, Tarun Jain: "We have a 100 per cent hedge for our forex borrowings. Hedging depends a lot on the business that a corporate is conducting, but I feel that one should hedge especially when the premiums are so low. You can still take a chance when premiums are 3-4 per cent, but in the current scenario, when it is so low, it makes sense to hedge or you run the risk of wiping out your entire earnings if there is a fluctuation."

Why Premiums Are Low

The sharp downward movement in forward premia has occurred because, at present, there seems to be a rush to sell dollars in the forward market by exporters and other entities in anticipation of further appreciation of the rupee vis-a-vis the dollar.
In response to this expectation, there is also a rush to "borrow" dollars (for repayments later) and convert these into rupees now. If the rupee does appreciate, the borrowers of dollars expect to make a financial gain (as fewer rupees would be required to repay the "borrowed" dollars). This phenomenon is also reflected in banks going "short" on dollars during intra-day and inter-day foreign currency trades.
While the demand for "borrowing" dollars for repayments later is strong, for the same reason, the demand by corporates and others for "purchasing" dollars in exchange for rupees in the spot and forward markets has become weaker. This has resulted in corporates and other market participants having larger "unhedged" exposures on their future dollar obligations. It has also led to some postponement of forward demand for dollars. These two phenomena, i.e. higher incentive to sell or "borrow" dollars and lower demand for actual purchase of spot or forward dollars have, inter alia, in combination put pressure on the forward premia.
Source: RBI

From a corporate point of view, the current perspective runs something like this. The rupee movement northwards is not good news for those earning in dollars. Taking cover on dollar receivables is a thought. Infosys is a case in point: It booked forward contracts amounting to $88 million as at end-March 2003, up from the $2 million in the same period of the preceding fiscal. Then again, earnings in Euro will gain as the rupee depreciates and losses on the dollar front can be compensated by gains here. Dollar-denominated loans can be repaid ahead of schedule. Telco has done so with a $75 million loan. Fresh dollar-loans can be taken as interest rates are low. Bharti Telecom has borrowed $315 million at 5.5 per cent recently. Dollar imports have become cheaper and net importers can keep open-positions as it makes little sense to pay to hedge when the rupee is strengthening.

Recent trends in exchange rate movements (see table) shows that the Euro has gained over the dollar continuously since September 2002. The overall gain has been 13.2 per cent. The reason for this can be traced to the economic fundamentals underlying these two economic areas. The rupee has appreciated against the dollar gradually by 2.6 per cent during this period.

This has been due to both the strengthening of the Euro as well as a very healthy balance of payments (BoP) during the first three quarters of the year. The rupee has correspondingly fallen vis-a-vis the Euro by 10.2 per cent in this period.

Senior bank treasurers are of the view that the fall in dollar against the Euro is really a part of the four-phase correction that is in progress. Therefore, the Euro will continue to strengthen during the next three months. The three phases were July-Sept 2001, March 2002-July 2002 and December 2002-January 2003. Says IndusInd Bank senior vice-president and head-treasury Sharukh Wadia: "If you were to ask me if exporters should start receiving in Euros, I would say that a consolidation phase is on. It may quote at 1.20, say three months down the line. Then it would make sense."

The dollar has also been affected by political and economic factors. West-Asia speaks for itself. On the economic front, the US is plagued by both fiscal and current account deficits. The fiscal deficit, some analysts say, will widen -- war expenses and the promised tax cuts; and could swell to $400 billion. The current account deficit is estimated to near $550 billion.

This means that roughly speaking, internal and fiscal deficits would be in the region of $1 trillion or nearly 9 per cent of the GDP. The US Secretary of Treasury has also stated that he would like to see a weaker dollar which will buoy exports; and to an extent, self-fulfilling.

But there are factors which may move diametrically opposite to curb this trend. One, a stronger Euro means that exports from the region will be at a disadvantage. This will compel the European Union (EU) to stall appreciation. In fact, the Euros appreciation is not due to a strong economic performance by the EU where the demand is, in fact, at historical low levels. (Shades of India!) Reconstruction in Iraq could give the US economy an impetus to reverse this trend. But this is longer-term variable.

And what does US entities feel about their economy American Express Bank, in its May 2003 report, notes that it expects "a US economic recovery in the second half of 2003 on the back of lower interest rates, stimulatory fiscal policy and lower oil prices. US corporates are very pessimistic now, but higher stocks, lower corporate bond spreads, and the profits rebound should bring stronger business investment later this year. Growth in Europe and Japan should pick up closely behind the US."

What is the Indian position The rupee has appreciated against the dollar due to an inherent strength built in the BoP and the weakening of the dollar relative to the Euro. Besides, some dealers feel that at present levels, the rupee is still undervalued. The appreciation was due to a high inflow of invisibles -- remittances, software receipts, NRI deposits, speedy repatriation of export proceeds and gains on revaluation of reserves. Given the shaky Gulf situation, remittances will continue to flow. Further, with the rupee appreciating and interest rates on NRI deposits being higher than those offered overseas, these inflows would persist.

Points out Mr Wadia: "The irony here is that banks really have no dollars with them. All those NRI dollars have been sold. If a corporate wants to reduce its cost of funds by swapping a dollar-loan, then dollars for such loans are not available." The RBI acknowledges this reality in its monetary and credit policy for the 2003-04: "The Reserve Bank has received various suggestions from banks and other market participants to meet the demand for borrowed dollars, arising from expectations of continued rupee appreciation. It has been suggested that banks should be permitted a higher level of foreign borrowings (over and above the present limit of 25 per cent of unimpaired Tier I capital), and/or higher inflows of foreign currency deposits should be encouraged (by increasing, for example, the ceiling interest rate on FCNR deposits which is, at present, 0.25 percentage point below Libor)."

All this means that while it hurts to receive dollars, paying is fun. Says Mr Rathi: "In the case of Grasim, we cover not less than 70 per cent of our forex borrowings. The RBI has done the right thing in cautioning corporates from leaving their forex borrowings unhedged. When premiums are at record lows, I think that you can hedge a major part of your borrowings while leaving a small portion unhedged to take the advantage of falling premiums."

A recent internal note prepared by a blue-chip on exchange rates noted that one can expect the rupee to strengthen, albeit very gradually, vis-a-vis the dollar in the next three months or so. An industrial recovery, and higher imports will lead to outflows which will put pressure on the exchange rate. The inflow through remittances would also slow down until such time that NRIs return home.

However, the rate is still not expected to go beyond the Rs 48 mark. The rupee-Euro position will be determined by a combination of what happens to the dollar relative to the Euro and the movement of the rupee-dollar quote. The combination of these twin factors means that one can expect the rupee-euro rate to remain virtually unchanged or depreciate marginally in the next three months which could get reversed by September or so if the recovery takes place in the domestic economy.

In its recent Monetary and Credit Policy, the RBI said: "One-way expectations of exchange rate or premia may not always be fulfilled. Present unhedged exposures seem to be on account of expectations on unconstrained appreciation of rupee. Movements in respect of exchange rates may not, however, be unidirectional."

But for the market, the storyline for now is: the rupee-dollar rate will appreciate further in the absence of RBI intervention in the next three months.