Working against a stronger rupee

DQW Bureau
26 Sep 2003

If there is one thing that has united IT service companies over the last one year, it has been the woe-begone story of the appreciating rupee. With the dollar continuing to lose shine against rupee, the effect has been telling on the operating margins of IT expor-ters. According to financial exp-erts, while the rupee deprecia-ted by around 5 percent over the last decade, the last 13 months saw it appreciating by close to 6 percent!

A quick look at some of the major IT exporters and the impact that uncovered foreign exchange (forex) receivables can have on their PAT, might help put things in perspective. According to the industry thumb rule, every one percent movement in the currency affects the PAT by 0.5 percent. Apply this rule to the total PAT of Rs 3,488 crore posted by the top 15 listed IT companies with substantial export earnings in India keeping in mind that the dollar lost shine by six percent point, and we realize that the possible loss in PAT due to uncovered forex receivables adds up to Rs 104.7

Hedging–The first choice

A search for ‘things to do’ in such a situation and one rea-lizes that there aren’t too many choices. Worse, the industry offers a confused picture on the ones that are available–hedg-ing being the first choice.

“Hedging is the practice of taking out a forward contract for your dollar inflow. In a for-ward contract, you fix upon an exchange value for the dollar with a bank covering a certain period of time and irrespective of the prevailing spot value at that point in time, the company can exchange its dollar receiva-bles at the agreed rate. Such contracts are plotted on the basis of a forward premium and aid in minimizing the exposure involved while providing cer-tainty to your realization,” explained KR Lakshminarayana, Corporate Treasurer,

With almost 70 percent of its total revenue being generated by exports, Wipro has been hedging on its forex exposures even in the times of a depre-ciating rupee and the strategy has been continued into the times of an appreciating rupee. The only exception, according to him, is that this time around the company has increased the quantum of forex receivables that is being hedged.

Infosys, whose forward contracts fixed till March helped it offset the impact of rupee appreciation, echoes the same statement. “While we were hedging our forex two years back when the rupee was depreciating, this time around the proportion of hedging has increased subs-tantially–from 10-15 percent of our net expo-sure during earl-ier days to 70-80 percent today,” informed V Bala-krishnan, Com-pany Secretary and VP
(Fina-nce), Infosys.

Though rela-tively new to the hedging game with forex cover being taken only about a year back, Mphasis BFL also suggests that hedging can be used even when the rupee is depreciating, to bring in better returns. “By under-standing the market, keeping alert and watching the percentage at which the rupee is depreciating, it’s possible to get a fix of a forward rate that can give better returns. Whe-ther the rupee is appreciating or depreciating, forward contract demands that expor-ter make a call,” said Alok Misra, VP (Finance),

No wonder then, companies like Satyam, iFlex, Polaris and NIIT are also fast climbing the hedging bandwagon. However, there are others who disagree with the idea of hedging as a trend and suggest it’s a short-term practice limited only to a few.

According to Shankar Venka-taraman, Partner, GlobalTech-nologyVentures, the apprecia-tion of rupee by its very nature is natural and a temporary process. “I really can’t unders-tand why the market is worried about a phenomenon that will affect only a few companies. Infact, only major companies need to worry about its effect on their operating margins,” he said.

True to this statement, com-panies like vMoksha and Aztec have remained on the edges of hedging. While Aztec began hedging part of its forex expo-sures as late as April of this year, vMoksha is still looking at forward contracts and might be covering 30-40 percent of its net exposures in another month’s time.

Ashok Soota, President, CII, also thinks that too much of the past is used in predictions for the future. “The rupee is not going to be appreciating for long-around only one to two more years–after which it will either fall or stabilize. Either ways, the appreciating rupee and its impact cannot fundamentally influence or change economic competitive-ness,” he said, adding that hedging cannot save compa-nies tide over the problem, if it persists for a long term.

Alternatives to Hedging

While the industry remains in a flux over the practice of hedging and how relevant it is in the long term, IT companies are certainly looking for ways to manage the risk caused by a stronger rupee. One such al-ternative, financial experts suggest, is the RBI’s recent introduction of foreign
curre-ncy–rupee option.

“Unlike forward contracts, these options give you power to exercise choice. This enables one to either go for the excha-nge rate you had fixed with the bank or opt for the spot rate in the market at that point in time. Till July of this year, such opt-ions were not allowed in the cu-rrency of the rupee,” said

However, the rupee options introduced by the RBI on July 7, 2003 comes with certain restrictions. While authorized dealers can offer only plain vanilla European options; not all banks have been given permission to take part in the instrument.

While some like Balakrish-nan of Infosys, believe that with growing awareness and larger players entering the fray, the industry and the government might come up with better opt-ions, others like Misra insist that forward contracts offer a much safer alternative, particu-larly when the rupee is moving steadily in one direction. Other IT companies when asked about rupee options, were eit-her unaware of the same or had not looked into the choice properly yet–indicating that the market has not
responded to rupee options enough for anyone to come out with an accu-rate prediction, for its future relevance.

Companies also said they were looking at cross currency transactions and distribut-ing their custo-mer base acr-oss different geographies to derisk their business. “Cur-rently, 16 per-cent of our exports reach Europe. We will be looking to increase this to 25 percent by next year,” said V Sundara-rajan, CFO, Aztec Software.

However, others like Laksh-minarayana disagree. “Cross currency transactions can bring down the risk faced by the appreciation of the rupee agai-nst one particular currency. Though extremely strong at the conceptual level and though Wipro has stood to gain with cross currency transactions from time to time, I believe that it fails as a feasible business mo-del and cannot be used consci-ously as a strategy,” he said. Lakshminaraya also dismissed the possibility of a natural hedge, pointing out that it does not apply in the case of Indian IT companies where the cost is in rupees and the billing is in dollars.

Taking a call

The appreciating rupee is a relatively new phenomenon to a country, whose industries have been used to working on a depreciating rupee for over a decade now. Consequently, the stronger rupee is posed to create problems and this has proved especially true for the IT industry.

Other than affecting actual cash flows, rupee appreciation also brings about an account-ing loss in the books when assets held abroad by a com-pany have to be declared in rupees. This loss is in many ways more important, for not only is it taken into account while calculating the profit and loss statement under Indian GAAP, there aren’t any forward contracts available to remedy the situation in this case.

Industry analysts suggest that the dollar might continue to weaken for another three years at the most, which means temporary measures of hedg-ing, rupee options and cross currencies can be used to tem-per the effect.

However, in case the rupee continues to appreciate, com-panies would then certainly have to explore newer areas and remedies–from charging a higher price to setting up operations in other geogra-phies and increasing offshore activities to reduce the compo-nent of rupee cost. According to Venkataraman and Soota, it was also time for companies to start looking seriously at inherent cost cutting measures and increased pricing to tackle the strengthening rupee better.

Experts feel that the eco-nomic viability and the poten-tial for profit that the long-term options can provide, are still open to debate and IT compa-nies do not need to immedia-tely consider the pros and cons of that argument. According to them, taking a call on the right prescriptive measures would solely depend on how long companies think the rupee will continue to appreciate.

Perhaps, the next few years would see the ‘rupee value’ turning out to be a pure game of protecting while waiting and watching!

Sathya Mithra Ashok & Shubhendu Parth 


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