The profitability of Indian corporates could worsen in the near-term as a result of erratic currency movements, especially as the trajectory of the rupee – which was in a depreciation mode until recently – has now become uncertain.
This is a result of the unexpected move by Reserve Bank of India (RBI) to tighten onshore liquidity and stabilise the rupee on July 15, which has caused some major headaches for Indian corporates.
As a result, this has prompted them to reconsider their hedging strategies for the long-term.
“We did see exporters beginning to hedge when the RBI measures came in as they took comfort that the central bank has got its act together,” said Priyanka Kishore, India analyst at Standard Chartered (StanChart) to Asiamoney PLUS on July 31. “This eased the upside pressure on USD/INR somewhat.”
“RBI’s measures have pushed the forward curve higher, making it expensive for importers to hedge,” she added. “However, persistent upside risks to USD/INR is likely to lead to an increase in importer hedging.”
The overall cost of hedging has spiked in recent weeks, with one-year forward points increasing from 300bp before the policy move to around 520bp after the changes. But this has recently come off to 480bp currently, note experts.
On July 25, the Indian rupee rose to a five-week high, advancing 1.5% to INR58.87 against the dollar paring its decline this year to 6.6%.
Some market participants were expecting a move as low as INR58, but given the rising uncertainty of RBI’s future policies, the currency once again weakened to around INR61 on August 5.
“Markets are talking about the new drop in dollar supply which is not surprising given the lack of conviction from RBI for further steps to come in,” said a Mumbai-based Indian economist. “There have been no further measures to deal with the current account deficit like the hiking of import duties.”
As a result, the heightened volatility in currency movements is not healthy for corporates, especially if it were to last for a few months, note analysts.
For example, India Rating’s and Research notes that Indian rupee depreciation has generally been accompanied by an increase in volatility.
The volatility reduces the benefit that exporters enjoy due to pure depreciation, adds the rating agency. Large-scale manufacturers and traders of real economy goods may be more affected by heightened volatility over a longer period of time.
“There are a lot of exporters who are hedged around the INR55, INR56 level against the dollar or below those levels [a year ago],” said a Mumbai-based FX strategist. “The ones that are hedged are actually taking a hit on the hedges because of the currency volatility.”
StanChart’s Kishore agrees: “Higher interest rates pose significant risks to banks’ and corporate balance sheets. If liquidity conditions stay tight for the next few months, then corporates may not be able to refinance debt easily.”
Corporate refinancing has now also become much more difficult, given that general costs of funding have increased due to the tighter liquidity situation.
For example, within hours of markets opening on July 16, overnight borrowing costs surged by 200 basis points (bp) to 9.5%. Some analysts said that it even touched 400bp at some point.
“For term borrowing, people will wait and watch,” said Brijesh Mehra, Head of International Banking for India and South East Asia, at the Royal Bank of Scotland (RBS) to Asiamoney PLUS on August 2. “The challenge for corporates is whether the rupee slide is really the beginning of a new trend or it is a one-off situation that will ease off once the volatility in global financial markets mitigates.”
If India’s liquidity tightening condition fails to ease in the coming months, some analysts expect long-term rates to follow the trend of rising short-term lending rates.
Foreign debt woes
While it has been a tough few weeks for corporates to manage their foreign currency (FX) exposure with regards to trade positions, the long-term impact of the rupee volatility on their foreign debt is also of concern.
For example, many Indian corporates maintain unhedged positions on their foreign currency debt, which is one of the biggest problems that has resulted in the poor financial performance of some, say experts.
Indian corporates have borrowed heavily from offshore markets to take advantage of lower rates,” said Kishore. “The big issue is that a substantial part of these borrowings are unhedged.”
“The SMEs rather would be most hit by these because they cannot uncover their unhedged exposures,” she added.
For companies with foreign currency debt, rupee depreciation will inflate the amount of on-balance sheet debt and its servicing amount – in rupee terms, notes India Ratings & Research.
For example, the amount of debt will increase by the factor in the table below if the rupee weakens to INR65 against the dollar. For example, a company for whom imports account for 80% or more of its cost of goods, will see its amount of debt rise to 111.3%.
For seven issuers, a rupee value of INR65 against the dollar will increase the local currency debt in the range of 10% to 20%, notes the rating agency.