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Forex derivative loss
May, 26th 2010

Indian corporate sector has raised significant funds through foreign currency loans like FCCBs, ECBs, etc., during FY07 and FY08. The corporate sector had preferred to keep its forex payable positions un-hedged in anticipation of appreciating INR trend to continue wherein FCCBs would eventually get converted into equity. While at the same time exports were hedged using various derivative instruments.

The foreign exchange derivatives contracts entered into by the Indian companies in the last two to three years has starting taking its toll now on its performance on the back of continual depreciation of the rupee against the dollar. During that period banks sensed an opportunity and approached the exporters with derivative products claiming that they have a product which can save the exporters from the impending Rupee appreciation losses.

According to a recent research the BSE 100 universe reveals that a large portion of forex payables is still outstanding and unhedged. The aggregate outstanding unhedged forex loan and gross currency derivative position for the BSE 100# universe was INR 1.3 tn and INR 1.9 tn,respectively (based on last reported balance sheets of companies).

During FY09, India Inc. was caught unguarded by steep INR depreciation (~28% vis--vis USD), which resulted in huge MTM losses on both unhedged loans and derivative contracts. Aggregate forex losses stood at INR 434.1 bn for BSE 100,of which, MTM loss on forex loans and outstanding forex derivative contracts (gross) was INR 243.9 bn and INR 99.3 bn, respectively, comprising 21.4% of reported PBT. However, revised accounting norms came to the rescue of these companies by allowing deferment of MTM losses, a significant portion of which has been reported off P&L.

Large amount of contracts were signed by the exporters with various banks which include SBI, ICICI Bank, Axis Bank, ABN Amro, etc. in gross violation of the existing Guidelines by RBI. This was done on the basis research data provided by these banks to exporters showing that how the Rupee would continue to go down and probably touch Rs.32 and below.

Major fluctuation was witnessed in USD/INR. American Dollar depreciated to as low as Rs39 per dollar and shot up to Rs.52 in a time span of less than a year with approximate variation of about 33%. While over a longer period if we compare from June 2002 to October 2009, USD has depreciated up to 42% in comparison to other recognized global currencies, whereas in India it has depreciated only by around 5%.

According to a recent research, companies like Wockhardt, Ranbaxy Laboratories, Suzlon Energy HCL Tech, etc have suffered huge losses due to the fluctuation of USD against Indian rupee.

Some of the companies such as Rajshree Sugars, Nahar Industrial Enterprises and Sundaram Brake dragged banks to court last year after they discovered the enormity of losses they have made. They claimed that the banks had promised trading profits and the contracts were not made for hedging purpose.

The participants in the derivatives got trapped based upon the historical movement of the Dollar over a prolonged time frame of seven years and this sudden movement from Rs.39 to Rs.52.

The Indian forex derivatives market is still in at an infancy stage with huge growth. The development of a vibrant forex derivatives market in India would critically depend on the growth in the underlying spot/forward markets, growth in the rupee derivative markets along with the evolution of a supporting regulatory structure.

Factors such as market liquidity, investor behavior, regulatory structure and tax laws will have a heavy bearing on the behavior of market variables in this market. Increasing convertibility on the capital account would accelerate the process of integration of Indian financial markets with international markets.

Introduction of derivative products tailored to specific corporate requirements would enable corporate to completely focus on its core businesses, de-risking the currency and interest rate risks while allowing it to gain despite any upheavals in the financial markets.

Increasing convertibility on the rupee and regulatory impetus for new products should see a host of innovative products and structures, tailored to business needs. The possibilities are many and include INR options, currency futures, exotic options, rupee forward rate agreements, both rupee and cross currency swaptions, as well as structures composed of the above to address business needs as well as create real options.

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