RBI intervention makes companies blind to rupee risks

Bloomberg

The Reserve Bank of India’s (RBI) commitment to a stable rupee is having an unintended consequence: local companies are getting complacent about hedging their overseas borrowings.
A gauge of expected rupee swings fell the most after Russia among 23 emerging markets over the last two years, thanks to the RBI’s regular interventions in currency markets and its success in boosting India’s reserves.
The unhedged foreign exchange exposure of local corporates and investors combined rose $78 billion between April 2014 and September 2016, Standard Chartered Plc’s calculations show.
With global risks such as the uncertainty surrounding US President Donald Trump’s policies, elections in Europe and monetary tightening by the Federal Reserve pointing to a tumultuous 2017, companies and investors could be in for a rude shock should the central bank let go of its rupee grip.
“A combination of market complacency and RBI intervention in the spot market to curb volatility” has contributed to rise in unhedged exposures, said Ananth Narayan, Mumbai-based regional head of ASEAN & South Asia financial markets at Standard Chartered Plc. A simultaneous increase in hedging costs has also deterred companies from buying protection, he said.
India doesn’t publish data on hedging, making it difficult to gauge how well firms are covered. That said, a recent study by the local unit of Fitch Ratings showed that 64 % of the Rs19.5 trillion ($291 billion) gross foreign-exchange exposure of the nation’s top 100 non-financial overseas borrowers was unhedged. Companies in the oil and gas, metals and mining, power and telecom sectors made up 75% of this. That not only threatens company margins and credit profiles, but also poses a systemic risk for Asia’s third-largest economy, according to India Ratings & Research.
“It’s a matter of concern for entities and sectors that are highly sensitive to a depreciating rupee,” according to Bansi Madhavani, an analyst at India Ratings who co-authored the report.
“There is no data or trend to back this hypothesis up, but the theory of ‘moral-hazard’ does suggest that central bank’s endeavor to anchor currency’s stability in fact leads corporates to keep their exposures unhedged.”
The rupee’s one-month implied volatility slumped 28% in the two years through December 2016. The drop is the biggest in Asia.
Indian companies need to repay $32.1 billion of foreign-currency bonds and loans by March 31, 2018, with 95% of that in US dollars, data compiled by Bloomberg show. This at a time when the median estimate in a Bloomberg survey shows the currency will slip to 69 per dollar by end-2017.
Thermax Ltd, an engineering and power-equipment maker based in Pune, near Mumbai, doesn’t keep any open foreign-exchange positions and takes a forward cover on its net exposure on a weekly basis, said M.S. Unnikrishnan, the company’s managing director and chief executive officer. “Companies shouldn’t look at temporary fluctuations in the currency for making profit,” he added.
A resumption of stock and bond inflows and a government budget viewed as fiscally prudent and pro-growth saw the Indian currency climb 1.9% over the three weeks ended 10 February, its sharpest rally in almost a year.
The rupee is broadly where it should be, RBI Governor Urjit Patel said in an interview broadcast on CNBC-TV18 on Friday, adding that the value of the currency is market-determined.
Alpana Killawala, a spokeswoman for the RBI, didn’t immediately respond to a request for comments. The central bank has said from time to time that it doesn’t target a specific rupee level and intervenes only to smooth volatility.
“The current bout of dollar weakness is a good opportunity for corporates to increase their hedge ratios,” said Standard Chartered’s Narayan. The dollar’s strengthening trend “will sustain over the medium term,” he said.