—Contributed by Vasant Prabhu

The Rupee inflation has seen unidirectional movement since April 07 versus its famous greenback, the dollar, which thus far still remains the world’s undisputed Forex currency benchmark. The 12% rise in rupee has brought its own peculiar problems to the SME Industry but least expected from one quarter, the derivative Hedging market. Initially presumed by most experts as a standard derisk strategy to beat the fluctuations of the rupee, it has suddenly been in the eye of a storm for inflicting financial damages to some medium sized companies recently. Is it the tip of an iceberg for another impending crisis in the financial jargon after the infamous PNs?  

Coming to think of it, the rupee rise in the global forex market has not been a singular phenomenon. All emerging currencies except for Indonesia & few others have appreciated against the dollar. However in India, having been attuned to a stable rupee valuation or rather Devaluation vs. the dollar for decades, the new phenomena has thrown the Industry, notably the small & medium export oriented industries off guard in managing a proper response mechanism to the crisis. While some have managed to address this amicably, others have gone overboard with disastrous consequences. So what exactly went wrong?  

As the rupee tumbled, so did the Revenues & Operating margins of companies which were impacted by the Hardening Interest rates of Debt money they had raised & less bang for the buck from overseas revenues .So a lot of companies found a quick way to make money to shore up their Quarterly results; Hedging through fancy derivative products & earn eye popping forex incomes. Ask any banker & they would swear by the ‘D’ word as a standard hedging strategy. Moreover they would have convinced you that any derivative product will bring a 95% profit probability to the table & the past 2 years performance was available as ready reckoner to drive home the point. No wonder there were so many CFO who bought into this theme, convinced their Boards, and played into the hands of their eager to please bankers who sold them fancy derivative products in a jiffy. Nobody wondered what would happen in the 5% loss scenarios of these products. Ask Hexaware who had to kiss off $25 million in losses or Sundaram multiplier whose losses are yet to be gauged fully. To beat higher interest rates & appreciating rupee cutting into profits, these companies (mostly earning export revenue) borrowed currency where it was low (mostly Swiss currency @2%) and lent in a country with higher Interest rates (US where it is 6%).The Interest differential made a neat pile which as forex income made up for much of the other ills in the P&L accounts. However that party was until the Swiss currency held on its own, but when it breached that price band safety in relative valuation to the dollar & appreciated by as much as 10%, all hell broke loose on the derivative hedging front. 

A recent Goldman Sachs report on where the Rupee is heading between the next 3 to 12 months has little comfort to offer. It says that the Rupee would hover between the 36.6 -39.5 price bands. What does all this mean to the Indian Industry? Is the wage arbitration game over for the IT & ITES Industries? If hedging is a solution to beat the problem, would the answer lie in pure vanilla hedging or structured hedging products?. There are no straight forward answers, but yes, there are some pointers on the way ahead

1. Cos will have to consciously build a basket of currencies in their revenue basket
2. Cos can look at  Dollarizing liabilities
3. Have employee compensation linked to dollar movements
4. Accept future contracts in Rupee terms
5. Build proper risk management systems to avoid knee jerk reasons to a Volatile environment. Which is here to stay.