Corporate greed in management of exchange and interest rate exposures
The sharp fall in rupee from 43.85 to 50.60 since end of July 2011 has caught most of corporate entities in the wrong foot; depreciation of over 15% in 3 months (at an alarming annualised rate of over 60%) has hurt many. It was normal and business as usual till July 2011 when domestic system felt the dollar liquidity squeeze driven by economic; monetary and financial woes from the Euro zone. Till then, there was good amount of capital flows to bridge the trade gap. The forward segment was also in supply driven mode with exporters leading cover of their dollar receivables and importers lagging their import payments for interest cost advantage. It was not seen sensible then to incur premium to buy the greenback when rupee was seen to be either stable or in appreciation mode. To make things worse, corporate entities were either keeping long term dollar borrowings un-hedged and/or converted their rupee liabilities into dollars. The reward is meagre 2-4% interest cost advantage; unmindful of the huge downside risk from adverse exchange rate movement. There was also strong (and baseless) opinion that market risk is hedged if pipe-line exports are matched against long term dollar liability while it is obvious that it would be relevant only when cash flows are in perfect sync. It is a penny wise; pound foolish strategy and we are already witnessing depressed corporate Q2 performance due to high forex loss provisions.
This is not bolt from the blue; it is repeat of what system faced in 2008-09 when rupee depreciated from 39.20 to 52.15 during January 2008 to March 2009; down by 33% in 14 months time. It is pity that lessons are not being learnt from past mistakes. It is high time for introspection to avoid business margin getting eroded by adverse market risk. The need is to stay prudent and sensible to avoid real losses unmindful of missing out on opportunity gains.
Now, it is possible that USD/INR spot is getting into new territory; base has already shifted from around 39.00 (since January 2008) to 44.00 (by July 2011). The risk of further upward shift into 49.00 is in preparation to set up new trading range of 49-52 in the near term. The market dynamics both from domestic and external sectors are not in favour of rupee getting into its bull phase in the short/medium term. This would mean that getting into uncovered short term carry-trade deals will be of high risk and may not result in interest cost effective solution. On the other hand, extended rupee weakness into 52 would attract long term carry-trade opportunities.
The bearish set up in rupee is triggered by widening current account deficit (escalation in import bill on higher commodity prices and decline in exports); reduced off-shore flows into debt and equity capital market; lower FX premium making forward dollars unattractive for exporters; growth and inflation woes and fiscal slippages leading to possible sovereign downgrade. We need to closely track these factors and look for improvements to get the rupee bulls back on street. The inability of the Euro zone to get out of its woes quickly and resultant dollar strength will trigger extended weakness beyond 52; this is the risk factor stake holders should take into account. The way forward is complex and uncertain; hence it is important for stake holders – importers; exporters and foreign currency borrowers – to run low risk/low reward hedging strategies. It is prudent to stay conservative; hedge exposures with marginal gains and run opportunity gains with pre-set exit levels to avoid downside risks. It is good not to lose monies when making money becomes tough and better to play with prudence rather than being greed!
J Moses Harding
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