The Reserve Bank of Indiaâ€™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 RBIâ€™s regular interventions in currency markets and its success in boosting Indiaâ€™s reserves.
The unhedged foreign exchange exposure of local corporates and investors combined rose $78 billion between April 2014 and September 2016, Standard Chartered Plcâ€™s calculations show.
With global risks such as the uncertainty surrounding US President Donald Trumpâ€™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.
â€œA combination of market complacency and RBI intervention in the spot market to curb volatilityâ€ 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 doesnâ€™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 nationâ€™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 Asiaâ€™s third-largest economy, according to India Ratings & Research.
â€œItâ€™s a matter of concern for entities and sectors that are highly sensitive to a depreciating rupee,â€ according to Bansi Madhavani, an analyst at India Ratings who co-authored the report.
â€œThere is no data or trend to back this hypothesis up, but the theory of â€˜moral-hazardâ€™ does suggest that central bankâ€™s endeavor to anchor currencyâ€™s stability in fact leads corporates to keep their exposures unhedged.â€
The rupeeâ€™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, doesnâ€™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 companyâ€™s managing director and chief executive officer. â€œCompanies shouldnâ€™t look at temporary fluctuations in the currency for making profit,â€ 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, didnâ€™t immediately respond to a request for comments. The central bank has said from time to time that it doesnâ€™t target a specific rupee level and intervenes only to smooth volatility.
â€œThe current bout of dollar weakness is a good opportunity for corporates to increase their hedge ratios,â€ said Standard Charteredâ€™s Narayan. The dollarâ€™s strengthening trend â€œwill sustain over the medium term,â€ he said.