Treasury Today Country Profiles in association with Citi

India’s summer of discontent

After suffering the biggest plunge against the US dollar since the early 1990s during the summer, the Indian rupee began to stabilise again in September. What were the origins of the rupee ‘crisis’ and how have Indian corporates adapted their hedging practices in order to manage heightened foreign exchange (FX) volatility?

Indian corporates had to adjust to a new reality over the course of the summer. For the best part of a decade, the Indian rupee remained remarkably stable, hovering for the most part at 45 to the US dollar. But that changed dramatically in April this year when the Federal Reserve announced plans to begin tapering its quantitative easing (QE) programme. The announcement from Chairman Ben Bernanke triggered a slide in which the currency fell 17% against the US dollar (see Chart 1).

Chart 1: Indian rupee versus the US dollar
Chart 1: Indian rupee versus the US dollar


For India’s corporates, the timing of the rupee’s slide couldn’t have been worse. In the past three years, there has been a significant increase in the dollarisation of debt on the balance sheets of Indian companies, as many looked to take advantage of low interest rates in global bond markets.

At the last measure, the country’s corporate sector now has a total of $48 billion in outstanding US dollar debt. As a consequence, Indian corporates are more vulnerable to currency shocks than at any time in recent history, says Deep Mukherjee, Director, Corporate Ratings at India Ratings and Research, a subsidiary of Fitch. In August, the group’s research revealed that the credit ratings of 65 of its 290 investment-grade issuers may come under pressure should the currency remain weaker than INR60/USD – although these specific corporates, contributing to 16% of the investment-grade debt, are unlikely to default in a stressful scenario such as this. If the rupee was to move beyond 65 for a sustained period, an additional 17 corporates would come under ratings pressure.

In this environment, full hedging of exposures becomes imperative. However, the task is complicated by volatility. Three-month implied volatility, a measure of expected moves in exchange rates used to price options, rose 649 basis points in August to 19.1%, making it the highest among the 48 global currencies tracked by Bloomberg. “In this environment, hedging becomes a nightmare,” says Mukherjee. “Our corporate clients want a stable rupee at any rate and this historical high in volatility is making it very difficult for them.”

Making the right call

Larsen & Toubro (L&T), a technology, engineering, construction and manufacturing company based in Mumbai, was taken by surprise when the rupee began to slide earlier in the year. In the company’s risk management policy, treasury is mandated to leave a certain amount of foreign exchange (FX) exposures open, leaving the team with the flexibility to hedge them depending upon how they see market conditions.

In April, prior to Bernanke’s indication that the Fed would soon begin to taper bond purchases, the company was relatively bullish on the currency. However, its balance sheet suffered a hit on the unhedged part when nervous investors began to pull their money out of emerging markets. Since then, the company has become much more bearish, making a conscious call to hedge 100% of its exposures, and has made all the correct judgements as the currency continued to slide further against the US dollar.

“Between 50 and 60 we didn’t quite catch it right,” concedes Harish Barai, Deputy General Manager of Treasury at L&T. “We thought the rupee was stretching a little bit and that it should bounce back. But we were caught out because the assessment on the current account and inflation was wrong.”

The volatility has complicated matters. In India, corporates can’t fully cancel or de-book on derivatives contracts; therefore, with the rupee moving up and down within a large range on a daily basis, making the right call becomes quite a challenge. “Things change so fast and there is so much commentary and data coming in all the time that it becomes very difficult,” says Vijay Kuppa, Treasury Manager, L&T.

Hedging instruments

Options might represent a useful means for corporates to hedge their FX risks in this volatile environment. The decision to use such instruments, however, depends on a number of factors including the size and sophistication of the treasury, the hedging budget, and how confident the risk management team feel about the direction of the market. According to Citibank, which has a market share of 25% of corporate FX transactions in India, the hedging of FX exposures has become a very active topic of discussion for its Indian corporate clients in recent months – a debate which is not just around liabilities on the balance sheet, but export earnings too.

While forwards are relatively simple and inexpensive, Citi India says that more corporates are now looking at other instruments, including options and range forwards. “I think most corporates are pretty savvy and are looking at all the different solutions,” says Rahul Shukla, Head of Corporate Bank at Citibank India. “Of course, you have to pay a premium with options, but you can also sell at a level in which you can collect a premium. If two months ago you were selling your exports forward, during the period the rupee was sliding downwards, you may well have thought it would be selling at 75 now – so you would be losing out. Therefore, you have to evaluate each alternative at a given point in time.”

Calm after the storm?

L&T’s treasury team say they have decided to stick mainly with conventional forwards for the time being. Although using such instruments can be more challenging in a volatile market, Barai and Kuppa believe their team have much more clarity now over the direction in which the market is heading, and therefore see no need to enter into pricey options contracts.

Kuppa is convinced that, thanks to recent interventions by the Reserve Bank of India (RBI), the worst of the volatility is over for the rupee. “In recent weeks we have seen the currencies of most emerging markets appreciating, but the rupee is staying where it is because of intervention. As long as the central bank is intervening in the market and is serious about controlling the currency, we shouldn’t see another flare up.”

Beyond the actions of the RBI, there are also a number of other reasons to believe that the country is turning the corner. Of the main economic challenges influencing the rupee at present – current account deficit, inflation, growth and the fiscal deficit – the prospects are already beginning to look more positive for at least two out of the four challenges. The rupee’s movements over this past year largely reflect the economy’s ailing fundamentals and, in particular, a current account deficit which widened considerably in the early part of 2013.

In March, many research brokers were forecasting a current account deficit in India around the 5% mark. But thanks to a hike in duties on the import of gold, those same brokers have now revised their projections downwards, towards 3% (see Chart 2). The narrowing of the current account deficit has clearly eased some of the nervousness in forex markets, helping the rupee to recover to around 62 to the US dollar.

Chart 2: Current account deficit
Chart 2: Current account deficit

DBS Group Research, October 2013

The fiscal deficit is also improving, thanks largely to lower current expenditures and higher non-tax revenue. According to recent figures published by the World Bank in October, revised data shows that the central government’s fiscal deficit in FY2013 reached 4.9% of GDP, well below last October’s target of 5.3% and considerably better than the 5.2% estimate made in March. On the other two fundamentals, the prospects are less certain. In the same report, the World Bank slashed its growth forecast for India, predicting GDP to decelerate to 4.4% in 1Q14, down from the 6.1% it forecast in April. However, there is optimism that next year may see some improvement, with the RBI estimating growth to recover to 6.2% in FY2015.

The report also states that core inflation has fallen to 2.4%, well within the RBI’s comfort threshold – this has helped bring Wholesale Price Index (WPI) inflation down to 5.3%. Nevertheless, L&T’s Barai says this is the one macroeconomic indicator that he is uncertain about. However, his gut feeling is there may be a small degree of respite in the coming months. And if, as a consequence, the central bank decides to lower the interest rates, it will surely provide further relief to the economy. “In India much concern remains regarding currency depreciation on the back of deteriorating macro parameters,” says Barai. “Now, finally, we see that some of them are being sorted out.”