Weathering the FX Storm (November 2018)

“There are risks and costs to action. But they are far less than the long range risks of comfortable inaction.”

  • John F. Kennedy
Freefall… landslide… One-way street… Over the past months, we’ve all heard these terms used to describe the movement in the USD/INR. Importers are seeing their blood pressures rise with every rise in the currency pair, with a majority having left their imports unhedged considering the costs involved in hedging. Exporters are also seeing their blood pressures rise, as most have hedged at lower levels with expectations that the INR would stall its upward march at some point along the way, which it unfortunately hasn’t. Then there are the exporters who do not believe in hedging their exposures, smiling all the way to the bank, dreaming of potential windfalls through such savings. They believe currency markets and their movements are best left to fate, or as they say, “Bhagwaan Bharose!’. But are these earnings resulting from planned strategies or incidental gains which could just as easily have reversed their fates? I, for one, am a strong believer in systematic hedging strategies. Not because I’m a consultant whose fees depend upon his client’s hedging strategies, but because I strongly believe in internal strategies over external luck. The time to act is now, especially when the markets are so volatile.  Let me explain why, in the form of the following FAQs: What is it that has been disrupting the news waves (and in a lot of cases, peoples’ sleep) with respect to the INR? The USD/INR started its uptrend in early 2018 on the back of global USD demand as the Fed commenced its journey of gradual rate hikes. Letters of Comfort (LoC) used by importers to avail cheap trade credits in foreign currency were banned by the RBI. The INR consequently saw a steep fall as importer-demand for the USD spiked in local markets at an unforeseen speed. Crude oil also started rising around the same time by as much as 25-30% in a short span. Global geopolitical tensions centered around the US such as the North Korean war-like situation, slapping steep tariffs on billions of dollars’ worth of goods from the EU, Canada, Mexico and China and the US-Iran standoff affected the pair with investors pulling out of emerging markets. China devalued its currency to negate the effect of the trade war by as much as 10%. With US-Iran tensions also escalating, India cleared its backlog of Iranian oil import payments in USD before the US sanctions took effect. The next steep fall in the INR started when it breached its all-time low of 68.86 levels and traded past 70 levels in just 3 trading sessions due to the US calling off the Iran nuclear deal and the consequential rise in oil prices. Turkey’s inflation crisis coupled with the fall in emerging market equities took the INR from 70.10 levels to 74.25 levels in no time. The INR’s recent rise was supported by the ease in crude oil prices as it tumbled by 5% with the Saudis pledging to meet short-falls in supplies. Locally, election-related uncertainty has not come into the picture yet, which is expected after November-18, possibly pushing the INR past 75 levels. The Fed meeting in December-18 would also play a very crucial role in deciding the future course of action on rate hikes. What are importers experiencing and what can be done now? A large part of imports into India are in the form of finished goods, imported for the purpose of trading in the domestic market. Margins in such businesses are wafer thin. So, a rise in one’s payment by 10% nullifies any chance of a profit in such transactions. In case of raw material importers, sales orders are priced according to cost of raw materials, amongst other factors. Now, the importer pays 10% more for their raw materials in a scenario where the sales price cannot now be altered accordingly, directly hitting profitability. For those importers who have hedged below 70 levels, it is a good job. But you now need to continue the process of hedging on dips in the pair so as not to lose those profits to real future losses that can be caused by inactivity at higher exchange rates. What are exporters experiencing and what can be done now? In case of exporters, we are competing in a market with an ever-increasing bevy of competitors, pushing us to accept thinner margins, making it critical to operate on low profits. Hedging as per a set system of tranches ensures that our major profitability is fixed, with little risk of our selling exchange rate being lower than our cost of manufacturing. To give you an example, some exporters who did not hedge were sitting happy at 75 levels thinking the party would never end. They are now licking their wounds with respect to the opportunity losses they are facing with the INR now below 73.50 levels. A good strategy would be to hedge 25-40% of receivables every month for 3 to 5 months period thereby creating a cyclical pattern going forward, with only 20-25% of each month’s receivables being left unhedged to take advantage of possible market moves. Any move downwards would not affect the monthly receivables as the remaining 75% would already be hedged, improving the weighted average considerably. What about companies with FX debt on the books? The RBI over the years has made available a number of forms of FX funding for corporates, from short-term options like Packing Credit (and till Mr. Nirav Modi did it in, Buyer’s Credit) to long-term options such as External Commercial Borrowings to help corporates stay competitive in the marketplace and also to boost exports to counter the country’s trade deficit. Companies who availed FX loans at 68-69 levels a few months back are now having to repay their FX bill where the USD received could have been converted at 74-75 levels, thereby taking a hit on the books to the tune of 9-10%. Long-term borrowers who have not hedged are in slightly murkier waters as loans availed below 65 levels by way of an ECB now need to repay interest only or interest plus part-principle at current 73-75 levels, eliminating any arbitrage they planned to enjoy by way of lower interest rates on FX funds. In case of short-term borrowings, companies should look at diversifying their FX debt with some portion of INR borrowings to ensure that sudden currency movements would not hurt the balance sheet as much. Also, companies should take advantage of government schemes for exporters such as Interest Equalisation. For importers, Buyer’s Credit would, in all probability, be brought back in a slightly altered manner soon. Interest and/or principle on long-term ECBs would need to be altered by way of currency/interest-rate swaps. So why is prudent FX strategy so important at such times? I’ll admit that some find the process cumbersome and/or complicated. Like all things around us, it can be problematic unless done through proper systems & processes. Also, FX hedging is not a one-off activity for immediate results. It needs to be an internalized thought process with planning and patience to reap benefits in the long-term. To put it simply, it’s not for those looking for instant gratification. Does a farmer leave the welfare of his crops solely to the monsoons, or setup an irrigation system to ensure his crops & profitability survive? Then how is this any different? With the current state of affairs, volatility is clearly here to stay for the foreseeable future, making it imperative with respect to your profitability to take matters into your own hands, rather than leaving it to chance or luck. How does Bizsolfx play a part in all this? Here at Bizsolfx, we help our clients in a number of matters related to banking and currency markets. We help setup robust processes and systems with respect to hedging which are stress-tested for various scenarios to ensure its validity. Another internal aspect of FX management that companies miss is bank margins on conversions and the timing of such conversions. All banks convert your receivables or payables at an unfavourable (to you) exchange rate, skimming some margins over the actual exchange rate. That means you end up receiving sums at a lower rate or paying at a higher one, directly affecting your bottom-line. We routinely work with corporates to drastically reduce these margins by way of negotiation with banks, thereby ensuring a higher bottom-line. As mentioned above, timing the conversions is a little tricky for companies as it requires a firm handle on the markets to understand the direction the exchange rate could move in the near future. A number of factors play a part here, too many for me to bore you with, in this article. But with the short-term volatility in the USD/INR close to 40-50 paise, we ensure that our clients are alerted about an opportune time to convert their funds within prescribed time-frames. As explained in this article, the currency market is not an easily controlled or a readable creature. So, ensure that internal systems are put in place to avoid losses. Our method here at Bizsolfx is internal strategy gets 80% importance, while external market movements are relied upon only up to 20% – the ever-effective 80:20 rule. A prudent FX strategy is important because business cannot be allowed to become a gambling den.  ]]>

1 thought on “Weathering the FX Storm (November 2018)”

  1. Dear Mr.Venkatchalam,
    Greetings ! I am sure you must be doing great.
    Really appreciate the well articulated article.
    Sometime ago, the India’s best treasury team of Reliance – Mukesh Ambani Group had around Rs. 15000 crs in their books with their strategic choices.
    Here our Govt. in their wishful thinking of turning the economy to a net export economy from net import economy allowed the free fall, although there were talks about Rupee kissing Rs. 75 levels in Jan-2018 itself.
    Many hidden political agenda are not known to us.
    Now US has allowed India- Iran deal without affecting sanctions for their own selfish interest. India should be bold to break free to convert India- Iran deals to pure Rupee Deals. With Demand on USD falling, Rupee will automatically strengthen. This is just a tip of the ice berg. There could many such strategic choices.
    Modi Govt. is quite capable of calling the rooster. Let us wait and watch, while resorting to safe hedging choices without taking undue risk.
    We as trustees should advise only safe game ” Hedge & Relax”.

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