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Working Against a Stronger Rupee

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DQI Bureau
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If there is one thing that has united IT service companies over the last one year, it has been the woebegone story of the appreciating rupee. With the dollar continuing to lose shine against the rupee, the effect has been telling on the operating margins of IT exporters. Consider this: according to financial experts, while the rupee depreciated by around 5% over the last decade, the last 13 months have seen it appreciating by close to 6%. A look at some of the major IT exporters and the impact that uncovered foreign exchange (forex) receivables can have on their profit after tax (PAT) figures might help put things in perspective.

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According to the industry thumb rule, every 1% movement in the currency affects PAT by 0.5%. Apply this rule to the total PAT of Rs 3,488 crore, which was posted by the top 15 listed IT companies in India during 2002-03, keeping in mind that the dollar depreciated by 6 percentage points, and it turns out that the possible loss in PAT due to uncovered forex receivables adds up to Rs 104.7

crore.

Hedging–The first choice 



A search for ‘things to do’ in such a situation and one realizes that there aren’t too many choices. Hedging is often the first choice for many IT companies, though it does not have the unanimous vote of the industry.

Hedging is the practice of taking out a forward contract for dollar inflow. In a forward contract, a company can fix (buy) an exchange value for the dollar with banks for a certain period in advance. This predefined value enables the company to exchange its dollar receivables at the agreed rate for that period, irrespective of the prevailing spot value at that point of time. 

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According to Wipro’s corporate treasurer K R Lakshminarayana, hedging as a practice is not new to Wipro unlike in many other IT companies. “With almost 70% of our total revenue being generated by exports, Wipro has been hedging on its forex exposures even in the times of a depreciating rupee and the strategy has been continued in these times of an appreciating rupee. The only exception is that this time around the company has increased the quantum of forex receivables that are being hedged,” he explained.

V Balakrishnan, company secretary and vice-president, finance, at Infosys echoes a similar sentiment. Infosys had forward contracts fixed till March 2003 and this helped it offset the impact of the rupee’s appreciation. “While we were hedging our forex two years back when the rupee was depreciating, this time around the proportion of hedging has increased substantially–from 10% to 15% of our net exposure earlier to 70% to 80% today,” Balakrishnan said.

Though relatively 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 understanding 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. Whether the rupee is appreciating or depreciating, forward contract demands that the exporter make a call,” said MphasiS’ vice-president, finance, Alok

Misra.

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While companies like Satyam, iFlex, Polaris and NIIT are also talking about hedging, others disagree with this idea.

According to Shankar Venkataraman, partner at GlobalTechnologyVentures, the appreciation of the rupee by its very nature is natural and a temporary process. “I really can’t understand why the market is worried about a phenomenon that will affect only a few companies. In fact, only the major companies need to worry about its effect on their operating margins,” he said. This is true for companies like vMoksha and Aztec that have remained on the periphery as far as hedging is concerned. While Aztec began hedging part of its forex exposures as late as April 2003, vMoksha is still looking at forward contracts and might be covering 30% to 40% of its net exposures in another month’s time.

Ashok Soota, president of Confederation of Indian Industry, also thinks that too much of the past is used in predicting the future. “The rupee is not going to appreciate for long–only one to two more years–after which it will either fall or stabilize.

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Either ways, the appreciating rupee and its impact cannot fundamentally influence or change economic competitiveness,” he said, adding that hedging cannot help companies tide over the problem if it persists for a long duration.

Alternatives to hedging 



While the industry is divided over the practice of hedging and its relevance in the long term, it is at the same time looking for ways to manage the risk caused by a stronger rupee. One such alternative, financial experts suggest, is the Reserve Bank of India’s (RBI) recent introduction of a foreign currency-rupee option. “Unlike forward contracts, these options give you the power to exercise choice. This enables one to either go for the exchange rate fixed with the bank or opt for the spot rate in the market at that point in time. Till July of this year, such options were not allowed in the currency of the rupee,” said

Misra.

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

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While some like Balakrishnan of Infosys believe that with growing awareness and larger players entering the fray, the industry and the government might come up with better options, others like Misra insist that forward contracts offer a much safer alternative, particularly when the rupee is moving steadily in one direction.

Other IT companies, when asked about rupee options, were either 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 accurate prediction for its future relevance. 

Companies also said they were looking at cross-currency transactions and distributing their customer base across different geographies to de-risk their business. “Currently, 16% of our exports reach Europe. We will be looking to increase this to 25% by next year,” said Aztec Software CFO V

Sundararajan.

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However, others like Wipro’s Lakshminarayana disagree. “Cross-currency transactions can bring down the risk faced by the appreciation of the rupee against 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 model and cannot be used consciously 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 in a country where industries have been used to working with 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 accounting loss in the books when assets held abroad by a company 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 also aren’t any forward contracts available to remedy the situation in this case. Industry sources reveal that the RBI has been approached by a certain IT company to explore the possibility of trading on the non-deliverables market (NDM) in London.

According to the sources, the RBI’s initial response has been positive and the company will continue to push for either a possible trading on the NDM or for the setting up of a similar mechanism in the country.

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

However, in case the rupee continues to appreciate beyond three years, companies would then certainly have to explore newer areas and remedies–from charging a higher price to setting up operations in other geographies and increasing offshore activities to reduce the component of rupee cost. According to Venkataraman and Soota, it is also time for companies to start looking at inherent cost cutting measures and increased pricing to tackle the strengthening rupee better.

Experts feel that the economic viability and the potential for profit that long-term options offer are still open to debate, and IT companies do not need to immediately 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.

According to the industry thumb rule, every 1% movement in the currency affects PAT by 0.5%

SHUBHENDU PARTH in New Delhi and SATHYA MITHRA ASHOK in

Bangalore/CNS

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