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To Hedge or Not to Hedge is the Dilemma

Published: 08th October 2014 06:00 AM  |   Last Updated: 08th October 2014 12:29 AM   |  A+A-

Many companies in India could be exposing themselves to potential financial risks by leaving their foreign exchange positions unhedged.

The rupee’s stability over the past year may be giving complacency to several companies to avoid paying a cost of covering their positions. Though the RBI is constrained by lack of comprehensive data, Rajan said unhedged exposures are significantly higher than they ought to be because of the stable rupee. They shouldn’t expect the RBI to defend the rupee, he cautioned.

“Companies without cover could get hurt badly even though they may be comfortable as of now,’’ said Prabal Banerjee, president of financial operations at the Essar Group in Mumbai. “Potentially India faces two key risks – of interest rate reversal in the US and West Asian crisis blowing up and pushing up crude prices,’’ he cautioned.

With the US having almost withdrawn its quantitative easing, and employment and housing sales data showing encouraging signs, the next step would be for it to start raising interest rates.

“The US rates would attract funds from emerging markets and cause serious depreciation of their currencies and to companies without hedged positions,” said Banerjee.

FII flows into Indian stocks was one-third lower in the quarter ended Sept 30 compared with the earlier quarter, even as inflows into debt over the same period doubled.

The other factor that could weaken the rupee is reversal in crude oil prices. India meets three-fourths of its energy demand from imported crude oil and any sharp rise could alter the real effective exchange rate. Any one of these event has potential to take rupee to 65-68 per dollar level, while the two together could push it past `70 per dollar.

More than two-thirds of the market, or a few hundred billion dollars, could currently be unhedged, estimates Banerjee.

“The global situation is unclear with chances of outflows as well as possible rise in inflows if global investment to India and local growth picks up,’’ says Krishnamoorthy Harihar, treasurer at First Rand Bank.

“For some export income provides a natural hedge from unhedged imports. Risk awareness among corporate has improved since 2009 global crisis,’’ he adds.

The rupee has weakened since May 21 level of `58.78 to close today at 61.43 per dollar.

“A fundamentally sound solution would be to make our currency markets deeper by allowing in more diverse participants including FIIs, mutual funds, primary dealers to be part of the currency market,’’ said Jamal Mecklai, CEO, Mecklai Financial. “At 8 per cent premium it is expensive for companies to cover,’’ he said.



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