Financial Foresights Jan13

Financial Foresights
VOL. NO. 3 ISSUL NO. 3 Q3 IY 12-13

Vicus, Rccc|icn an |rui|icn
FEDERATION OF INDIAN CHAMBERS OF COMMERCE AND INDUSTRY
|nus|rqs Vcicc fcr Pc|icq Cnangc
Foreign Exchange Risk Management
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About FICCI
LslalIished in 1927, IICCI is lhe Iargesl and oIdesl apex lusiness organisalion in
India. Ils hislory is cIoseIy inlervoven vilh Indias slruggIe for independence, ils
induslriaIizalion, and ils energence as one of lhe nosl rapidIy groving gIolaI
econonies. IICCI has conlriluled lo lhis hisloricaI process ly encouraging delale,
arlicuIaling lhe privale seclors vievs and inuencing poIicy.
A non-governnenl, nol-for-prohl organisalion, IICCI is lhe voice of Indias lusiness
and induslry. IICCI dravs ils nenlership fron lhe corporale seclor, lolh privale
and pulIic, incIuding SMLs and MNCs, IICCI enjoys an indirecl nenlership of over
2,5O,OOO conpanies fron various regionaI chanlers of connerce. IICCI provides a
pIalforn for seclor specihc consensus luiIding and nelvorking and as lhe hrsl porl of
caII for Indian induslry and lhe inlernalionaI lusiness connunily.
DISCLAIMER
AII righls reserved. The conlenl of lhis pulIicalion nay nol le reproduced in vhoIe or in parl vilhoul
lhe consenl of lhe pulIisher. The pulIicalion does nol verify any cIain or olher infornalion in any
adverlisenenl and is nol responsilIe for producl cIain and represenlalion.
ArlicIes in lhe pulicalions represenls personaI vievs of lhe dislinguished aulhors. IICCI does nol
accepl any cIain for any viev nenlioned in lhe arlicIes.
Acknowledgments
We thank our Partners
Partner Exchange
Industry Insights Partner
Contents
1. PREFACE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
2. INDUSTRY INSIGHTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
The Risk Management Imperative - 9
Mr. V.K. Snarma, |xccu|itc Dircc|cr, Rcscrtc 8an| cf |nia
Role of Foreign Exchange Risk Management in Indian Corporate Performance - 17
Mr. 8 A Pra|na|ar, Cnairman c Managing Dircc|cr, Annra 8an|
Divining the Rupees future 21 -
Mr. Sauga|a 8na||acnarqa an Mr. A|nisnc| Upanqaq, Scnicr Vicc Prcsicn| an Scnicr Managcr,
8usincss an |ccncmic Rcscarcn, Axis 8an|
The macroeconomics of managing the rupee 25 -
Mr. |nrani| Scn Gup|a, |nia |ccncmis|, 8an| cf Amcrica Mcrri|| |qncn
Foreign Exchange Risk Management 30 -
Mr. Vipu| Cnanra, Managing Dircc|cr, Ccrpcra|c Sa|cs c S|ruc|uring , Scu|n Asia Mar|c|s
Mr. Himansnu Kaji, |xccu|itc Dircc|cr, |c|uciss |inancia| Scrticcs |imi|c
Mr 8a|q K P, Ass| Gcncra| Managcr, |ccra| 8an|.
Foreign Exchange Risk Management for Corporates 42 -
Mr. Mcnan N. Sncnci, Prcsicn|- Grcup Trcasurq c G|c|a| Mar|c|s, Kc|a| Maninra 8an| |imi|c
A perspective on the trends in the foreign exchange market and identifying and -
managing foreign exchange risk 46
Mr. Ramasuamq Gctinan, Vicc Prcsicn| (Ccrpcra|c |inanccc Ris| Managcmcn|),
|arscn c Tcu|rc |imi|c.
Sm|. Usna Anan|nasu|ramanian, |xccu|itc Dircc|cr, Punja| Na|icna| 8an|
Snri Nisnan| ]na, Vicc Prcsicn| (Rcscarcn) Snri Sc|taraj Ka|qanasunaram, Dcpu|q Gcncra| Managcr
(|crcx, |inancia| |nginccring c Ncu Prcuc|s)
Mr. ]amcs 8crrq, Cnicf |nfcrma|icn Offccr, |nia c Scu|n Asia, S|anar Cnar|c 8an|
Mr. Anan|n Naraqan G, Cc-Hca cf Inc|csa|c 8an|ing, Scu|n Asia, S|anar Cnar|c 8an|
Foreign Exchange Risk Management-The way forward 69 -
Mr. Apccrt Sritas|ata, Rcscarcn Assccia|c-|inancia| Scc|cr, ||CC|
3. THE POLICY PULSE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75
Banking Sector 76 -
Capital Markets Sector 79 -
Insurance Sector 82 -
Reforms Tracker -
4. FICCIS DATA CENTRE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87
Indian Economy-An Update 89 -
Investment Banking Updates 92 -
Markets Watch 97 -
5. FINANCIAL SECTOR EVENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98
Synopsis of Past Events 98 -
6. FINTAINMENT SECTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .99
Preface
IICCIs IinanciaI Ioresighls is lhe agship research digesl of
IICCIs IinanciaI Seclor Division. Wilh lhis quarlerIy pulIicalion
ve ain lo faciIilale a conprehensive forun for diaIogue lelveen
India Inc. and poIicy nakers lherely providing necessary
direclions lo aII slakehoIders incIuding lusinesses and reguIalors.
The issues discussed herein are invaIualIe inpuls for IICCIs
exlensive nelvork of induslry nenlers and slakehoIders. The Q3
Issue of IY12-13 as such focuses on lhe inporlanl issue of Ioreign
Lxchange Risk Managenenl in India.
Wilh lhe disnanlIing of lrade larriers posl econonic IileraIizalion
in India, lusiness houses slarled acliveIy approaching foreign
narkels nol onIy vilh lheir producls lul aIso as a source of capilaI
and direcl inveslnenl opporlunilies. India Inc has reached lhe
scaIe and size of lhe gIolaI order and severaI Indian organizalions
are loday vorId Ieaders in lheir respeclive seclors. Arriving on
lhe gIolaI scenario suljecls corporalions lo diversify revenue
slreans in various geographies, lhus Ieading lo invoicing in gIolaI
currencies such as USD, CI and LUR lo nane a fev. SiniIarIy,
access lo various lorroving nechanisns and dell narkels had
aIso Ied lo increased non-INR exposure on looks.
A lroad lased, aclive and Iiquid forex (Ioreign Lxchange)
derivalives narkel lhus lecones essenliaI lo provide lusinesses
vilh a speclrun of hedging producls for effecliveIy nanaging lheir
foreign exchange risk exposures. AIlhough India has vilnessed
inprovenenl in infornalionaI and operalionaI efhciency of lhe
foreign exchange narkel, lhis has happened al a haIling pace.
Il is in lhis conlexl lhal lhrough lhe voice of sone of Indias Ieading
nanes in lhe hnanciaI seclor, ve viII lake a cIoser Iook al lhe currenl
fornalive phase of deveIopnenl of lhe foreign exchange narkel
and lake slock of lhe inilialives laken ly corporale enlerprises in
idenlifying and nanaging foreign exchange risk.
We Iook forvard lo your vievs and suggeslions lo heIp us
inprove lhe conlenl of lhe digesl and nake il nore reIevanl and
infornalive.
Dr. A. Didar Singh
Secretary General
FICCI
Industry Insights
In association with
9
Industry Insights
The Risk Management Imperative
1. Whal vilh lhe calacIysnic and
apocaIyplic evenls Iike lhe US
dovngrade and Lurozone sovereign
dell crisis overvheIning lhe vorId
and India, lhe Iasl lvo years have leen
characlerized ly unprecedenled and
excessive voIaliIily in assel prices and
currency vaIues, calapuIling lhe crilicaI
inperalive of Risk Managenenl lo lhe
cenlre-slage Iike never lefore. Againsl
a hnanciaI lackdrop as sonler,
lraunalic, porlenlous and solering
as lhis, IICCIs inilialive in focusing
allenlion on lhe risk nanagenenl
inperalive has cone nol a day loo
soon !
2. Hovever, if onIy lo reinforce lhe
conlexl of lhis inilialive, I cannol slress
nore lhe connonaIilies lelveen lhe
crisis of 2OO8-O9 and lhe currenl one.
SpecihcaIIy, lhe rupee deprecialed
againsl lhe doIIar ly aloul 24
lelveen March 2OO8 and March
2OO9 (Rs. 39.8O lo Rs. 52.2O) vilh lhe
voIaliIily doulIing lo aloul 12 (as
neasured ly annuaIised slandard
devialion of daiIy percenlage changes).
And during lhe currenl crisis, lhe rupee
deprecialed ly aInosl 18 in Iess
lhan 6 nonlhs lelveen Augusl 5 and
Decenler 15, 2O11, vilh lhe voIaliIily
aInosl doulIing fron aloul 5 lo 12.
LquaIIy deserving of lhe allenlion is lhe
facl lhal since March 2O1O lo dale, lhe
Mr. V.K. Sharma, Lxeculive Direclor, Reserve ank of India
The last two years
have been characterized
by unprecedented and
excessive volatility in
asset prices and currency
values, catapulting the
critical imperative of
Risk Management to the
centre-stage like never
before
________________________________________________________________________________________________________
This arlicIe is an updaled and revised version of lhe Keynole Address deIivered ly Mr. V.K. Sharna, Lxeculive Direclor, Reserve ank
of India, al lhe angaIore Chanler of Induslry and Connerce, angaIore, India, The vievs expressed are lhose of lhe aulhor and nol
of lhe Reserve ank of India.
10
www.ccI.cnm/nancIa!-fnrcsIghts
Industry Insights
Reserve ank hiked key poIicy rales 13
lines, raising lhe effeclive poIicy rale
fron 3.25, (lhe effeclive rale lhen
leing lhe Reverse Repo Rale) lo 8.5
(lhe effeclive rale currenlIy leing lhe
Repo Rale), resuIling in a cunuIalive
lighlening of 5.25 in a naller of
a IillIe over 1-1/2 years ! LquaIIy
signihcanlIy, gIolaI connodily prices
have leen jusl as voIaliIe since lhe
crisis of 2OO8, crude prices, afler rising
sleepIy lo US $ 147 per larreI in }uIy
2OO8 and lhen faIIing precipilousIy lo
$ 32 per larreI in Decenler 2OO8, have
risen fron US $ 32 lo around US $1OO
nov ! The reason vhy I have lroadened
lhe canvas lo aIso incIude inleresl rales
and connodilies is lo approach lhe
suljecl naller of Ceneric IinanciaI
Risk Managenenl hoIislicaIIy, as il
is nol jusl currency risk aIone, lul
inleresl rale and connodily price risks
jusl as nuch, lhal represenl signihcanl
sources of risk nol jusl lo lusinesses
lhenseIves lul equaIIy lo hnancing
lanks and lhus polenliaIIy lo syslenic
hnanciaI slaliIily !
3. In an increasingIy gIolaIised lrade
and inveslnenl environnenl, lusiness
and induslry have inevilalIy lo conlend
vilh, and nanage, nol jusl lheir
nornaI core lusiness risks, lul aIso
hnanciaI risks Iike foreign exchange,
inleresl rale, and connodily price
risks. WhiIe il viII le presunpluous
on ny parl lo even conlenpIale, nuch
Iess allenpl, leIIing lhe largel audience
of lhis arlicIe hov lo nanage lheir
nornaI lusiness risks, I do consider il
ny dharna lo allenpl shining Iighl on
hnanciaI risk nanagenenl, conprising
foreign exchange, inleresl rale and
connodily price risks. AccordingIy,
I have crafled, and propose lo deIiver
lhrough lhis arlicIe, vhal I lhink, given
ny ovn inleIIecluaI sense of praclice,
a praclicaI, nuls-and-loIls, and do-il-
yourseIf looI-kil, eIucidaling lhe 'vhal
(i.e. vhal nusl le done), lhe 'vhy (i.e.
vhy il nusl le done), lhe 'hov (i.e.
hov il nusl le done), and lhe 'vhen
(i.e. vhen il nusl le done) of hnanciaI
risk hedging, vhich in ny reckoning
is as cIose as, or, lhe cIosesl, praclice
couId gel lo lheory.
4. efore I proceed furlher, I vouId Iike
lo pul lhe suljecl naller of IinanciaI
Risk Managenenl in appropriale
perspeclive. Risk Managenenl is nol
aloul eIininaling , or vhich is lhe
sane lhing as conpIeleIy hedging oul,
risk lul aloul hrsl delernining , Iike
ones pain lhreshoId, risk loIerance
lhreshoId and lhen aIigning an enlilys
exisling risk, le il currency, inleresl
rale or connodily price risk, vilh ils
risk loIerance lhreshoId. Having said
lhal, il vouId aIso le in order lo have
a sense of hov risk ilseIf is dehned
and neasured. Risk is uncerlainly of
fulure oulcones such as cash ovs.
In hnance lheory and praclice, il is
lypicaIIy neasured ly annuaIized
slandard devialion of a line-series
of percenlage changes in assel prices.
WhiIe courling hnanciaI risks in
pursuil of hnanciaI relurn is lhe slapIe
and dharna of lanking and hnance
induslry, il is nol so for induslriaI and
nanufacluring lusinesses ! The slapIe
and dharna of lusiness and induslry
is courling lheir nornaI core lusiness
risks in pursuil of deIivering a narkel-
conpelilive slalIe relurn on equily lo
sharehoIders.
5. I lurn nov lo lhe suljecl-naller
proper of hnanciaI risk nanagenenl. I
propose lo deaI, in sone delaiI, vilh lhe
specihcs of risk nanagenenl slralegies
for hedging foreign exchange, inleresl
rale and connodily price risks. I
vouId very slrongIy encourage
lusiness and induslry lo invarialIy
hedge lheir acluaI risk exposures
vilhoul exceplion as a lase-case
slralegy. To say lhe Ieasl, lhis is ly
far lhe nosl conservalive and prudenl
slralegy. Indeed, in lhe lackground
of lhe neasures announced ly lhe
Reserve ank of India on Decenler
15, 2O11, vilhdravaI of lhe faciIily of
canceIIing and relooking of forvard
conlracls Ieaves no olher oplion lul
lo foIIov lhe lase-case slralegy. ul
as Iearned, and discerning, readers of
lhis arlicIe viII readiIy recognize, lhe
excrucialing and vrenching voIaliIily,
experienced recenlIy, unqueslionalIy
allesls lo lhe credenliaIs of such a lase-
case slralegy of leing fuIIy hedged.
Of course, il does nean lhal risk is
leing conpIeleIy eIininaled and,
lherefore, so is leing hnanciaI relurn.
ul lhen, lhis is jusl as veII lecause,
as I said lefore, lhis is nol lhe dharna
of lusiness and induslry vhose
cardinaI principIe il nusl le lo earn
lheir narkel-conpelilive relurn on
equily fron lheir nornaI core lusiness
risks onIy lo lhe conpIele excIusion
of foreign exchange, inleresl rale and
connodilies price risks !
6. As regards forex risk exposure of
lusiness and induslry, I vouId Iike
lo lake readers of lhis arlicIe lack
in line lo lhe Iale 199Os vhen lhe
Indian corporale seclor venl in for
Iarge scaIe LCs. These LCs vere
11
Industry Insights
aInosl conpIeleIy for doneslic rupee
expendilure and vere noslIy un-
hedged and LIOR-Iinked-oaling-
inleresl-rale lased. Indeed, so aIso
vas lhe case vilh lhe corporales in
ThaiIand and Indonesia vhich lecane
reposilories of unhedged currency and
inleresl rale risk exposures crealing
credil risk for lhe doneslic lanks. The
saving grace vas lhal, unIike in Lasl
Asian counlries, LCs ly corporales
in India vere suljecl lo overaII Iinils
under Aulonalic and ApprovaI roules.
I an sure lhe readers vouId recaII lhal
such un-hedged and oaling-rale-
lased foreign currency exposures
cuIninaled evenluaIIy inlo lhe nov-aII-
loo-faniIiar apocaIyplic denouenenl,
enlaiIing forex Iosses in India and lhe
Lasl Asian Currency crisis in Indias
neighlourhood ! I vouId, lherefore,
very slrongIy connend lhal lusiness
and induslry le nol lenpled and
enliced ly noninaIIy Iov inleresl rales
and invarialIy rigorousIy evaIuale
such foreign currency lorroving
oplions, lenchnarking lhen againsl
lhe conparalIe rupee lorrovings.
OnIy if lusiness and induslry hnd lhe
Iong-lern foreign currency lorroving
cosls are Iover, on a fuIIy-hedged
lasis, lhan lhe conparalIe rupee
lorroving cosls, nusl lhey choose
such lorroving oplions ! I aIso regrel
lo have lo say lhal lhe currenl popuIar,
lul uninforned and lolaIIy unlenalIe,
refrain has leen lhal forvard cover for
foreign exchange for Ionger lern such
as hve years, or so, is nol avaiIalIe, vhal
is avaiIalIe is oul lo one nonlh, lhree
nonlhs, six nonlhs and naxinun
one year and nol leyond. ul I
vouId Iike lo enIighlen lhe discerning
readers of lhis arlicIe lhal a Iong-lern
forvard foreign exchange hedging
soIulion can le easiIy cuslonized ly
lanks ly recourse lo vhal is knovn as
roIIing hedging slralegy vhich sinpIy
invoIves sinuIlaneousIy canceIIing,
and relooking, a shorl-lern forvard
exchange conlracl unliI lhe desired
Iong-lern nalurily. IncidenlaIIy,
such sinuIlaneous canceIIalion
and relooking of forvard conlracls
for roIIover is exenpled fron lhe
RI reslriclions inlroduced on 15lh
Decenler, 2O11. Of course, preciseIy
lhe sane slralegy can le repIicaled in
lhe exchange-lraded foreign currency
fulures narkels as veII. Conlrary lo
lhe popuIar perceplion, lhis slralegy
is fairIy sinpIe and perfeclIy do-
alIe and Iocks in lhe originaI slarling
spol exchange rale. Whal, in olher
vords, lhis enlireIy unexceplionalIe,
and highIy desiralIe, slralegy does
is sulslilule voIaliIily of lhe spol
exchange rale vilh lhal of forvard
nargins al each roII over dale. Il
is enpiricaIIy, and anecdolaIIy,
eslalIished lhal voIaliIily of forvard
nargins is far Iess onerous lhan lhal
of lhe spol exchange rale. Therefore,
I vouId very slrongIy encourage
lusiness and induslry lo roulineIy
avaiI of lhis hedging soIulion lolh lo
cover forex risk of Iong-lern inporls
and Iong-lern foreign currency
lorrovings.
7. I lurn nexl lo lhe olher very popuIar
foreign currency funding oplion,
naneIy, Ioreign Currency ConverlilIe
onds (ICCs). I nusl confess lhal
I have leen very inlrigued ly vhal
I have read in lusiness and hnance
nevspapers. The sense lhal I gol vas
lhal corporales use ICCs lo raise
Iong-lern hxed rale foreign currency
funds hoping lhal overseas inveslors
viII exercise lhe oplion enledded
in ICCs and converl inlo equily !
And preciseIy for lhis reason, il has
leen noliced lhal corporales do nol
nake provision of doneslic rupee
and foreign currency resources
!! In facl, such lasic nolivalion
underIying lhe ICC-lased funding
slralegy is conpIeleIy anlilhelicaI
lo lolh corporale hnance lheory
and inlernalionaI praclice and lurns
lhe enlire ralionaIe of such funding
slralegy on ils head ! This is lecause
lhe very raison dlre of ICC funding
oplion is lo Iover lorroving cosls
leIov lhal of an olhervise conparalIe
pIain- vaniIIa non-converlilIe foreign
currency lond. The shorl poinl is
lhal lhe ICC lorrover is lailing
lhe overseas inveslor vilh an equily
oplion kicker/appelizer, enledded in
an olhervise conparalIe pIain- vaniIIa
non-converlilIe lond. LffecliveIy,
in lhis slruclure, overseas inveslor in
ICC purchases an enledded oplion
and pays an oplion preniun in lhe
forn of Iover coupon on ICC. I
hardIy need leIalor lhe poinl lhal
equily is aIvays nore expensive
lhan dell capilaI of vhalever kind,
incIuding even junk/ high-yieId
londs ! So I vouId urge lusiness and
induslry lo fuIIy provide doneslic
rupee/foreign currency resources lo
neel polenliaI IialiIily under ICCs,
ralher lhan hope lhal ICCs viII le
12
Industry Insights
converled vhich, in facl, if anylhing,
can le lhe case of overseas inveslors,
lul cerlainIy nol, of issuers of ICCs !
8. AIlhough as serious as foreign
exchange risk, inleresl rale risk has nol
conpeIIed as nuch allenlion in lhe
Indian dell narkel space. If onIy lo
have a sense of hov signihcanl, and
serious, il can le, I invile allenlion lo
vhal I said aloul lhe key poIicy rales
rising cunuIaliveIy ly 5.25 since
March 2O1O lo dale ! }usl Iike unhedged
foreign currency exposure, Iong-lern
oaling rale Ioans represenl a source of
signihcanl risk nol onIy lo lusinesses
lhenseIves, lul equaIIy lo hnancing
lanks as lhey lransfer inleresl rale risk
fron Ienders lo lorrovers, effecliveIy
sulsliluling inleresl rale risk of Ienders
vilh polenliaI credil risk in lerns of
crealing polenliaI non-perforning
Ioans ! Al anolher IeveI, as hxed rale
Ioan has nore cerlainly, and hence Iess
risk, lolh for lorrover and Iender, il
shouId le preferred lolh ly lorrovers
and Ienders aIike. Thus, for inleresl
rale risk nanagenenl, lhe lase-case,
risk-neulraI slralegy, is invarialIy hxed
rale Iong-lern funding ly corporales.
ConlexluaIIy, lhe currenl popuIar
refrain in lhe poIicy delale is lhal
alsence of a conpelilive, Iiquid, deep
and efhcienl corporale lond narkel
has leen lhe undoing of infraslruclure
hnancing vhich lypicaIIy invoIves
Iong-lern hxed rale funding. And
as lo vhy lanks cannol nake Iong-
lern hxed rale infraslruclure Ioans,
lhe slock refrain is lhal lhis viII creale
assel IialiIily nisnalch in lanks
laIance sheels as lheir IialiIilies are
noslIy shorl-lern. Lven lhen lanks
have a conlined infraslruclure Ioan
porlfoIio of aloul Rs.6 lriIIion (US $ 11O
ln), represenling aloul 9 of lhe lolaI
lank assels in India of Rs.71 lriIIion (US
$ 1.35 lriIIion) as of 31sl March, 2O11.
As againsl lhis, corporale lond narkel
is around Rs.9 lriIIion (US $ 17O ln).
In lhis lackground, il is nolevorlhy
lhal lhe IIanning Connission have
recenlIy eslinaled infraslruclure
funding requirenenls, over lhe nexl 5
years, al cIose lo Rs. 55 lriIIion. WhiIe
prina facie lhis nay seen a daunling
and laII order, on a cIoser scruliny, il
lurns oul lhal il is nol reaIIy so. Why I
say lhis is lecause of lhe facl lhal lank
assels have grovn al a Conpounded
AnnuaI Crovlh Rale (CACR) of 2O.5
during lhe Iasl six years and reaI CDI
has grovn al a CACR of 8.2 during
lhe Iasl seven years. Thus, il is readiIy
seen lhal given lolaI lank assels of
Rs. 83 lriIIion as of 31sl March, 2O12,
a CACR of 2O.5, lolaI lank assels
viII grov lo Rs. 21O lriIIion over lhe
nexl hve years and assuning lhal, as
againsl 1O of lolaI lank assels nov,
lanks can hnance infraslruclure uplo
15 of lolaI assels, lhey vouId easiIy
le hnancing aloul Rs. 32 lriIIion in
infraslruclure Ioans. And furlher,
assuning lhe currenl Ieverage in
infraslruclure hrns of aloul 4 lines,
equily capilaI of aloul Rs.14 (55 4)
lriIIion viII le required, Ieaving a
gap of aloul Rs. 9 lriIIion vhich can
easiIy le hnanced ly corporale lond
narkel, vhich aIso, assuning lhe
currenl lond narkel lo lolaI lank
assels ralio of 12.5, viII have grovn
lo Rs. 26 lriIIion ! ul lhis connon
and popuIar, lul again uninforned
and counler-inluilive, refrain lhal
lanks cannol fund Iong-lern hxed rale
infraslruclure assels is unlenalIe in
lhal lanks have nol lhoughl of using a
very 'vilranl Inleresl Rale Svap (IRS)
narkel, vhere oulslanding nolionaI
principaI anounls aggregale Rs 6O
lriIIion (US $ 1.14 lriIIion) (aInosl 82
of lolaI lanking assels in India as aIso
of lhe nalions CDI) ! Ior lanks
can easiIy lransforn lheir shorl lern
IialiIily inlo a Iong-lern hxed rale one
and lhus creale a synlhelic Iong-lern
hnancing soIulion for Iong geslalion
infraslruclure projecls ly doing lhe
foIIoving :
(i) Receive hxed rale for one year
and pay oaling overnighl rale in
lhe IRS narkel. (Assuning lanks
average IialiIily is aloul one
year)
(ii) Receive oaling overnighl rale
and pay 5/1O-year in IRS narkel.
This effecliveIy synlhelicaIIy
lransforns a one-year oaling rale
IialiIily of lank inlo a synlhelic
5/1O-year hxed rale IialiIily. y
Ioading nargin over lhis rale,
lanks can nake a 5/1O-year hxed
rale Ioan lo an infraslruclure
conpany. And, signihcanlIy,
considering lhal IRS lrades aloul
14O lo 15O lasis poinls leIov
sovereign yieId, il is vin-vin for
lolh lanks and infraslruclure
conpanies vho, even afler
lankers spreads/ nargins, viII
le alIe lo lorrov al around 5/1O
year Covl. lond yieId (currenlIy
8.4O). Thal is as sinpIe as il can
gel in lerns of crealing lvo-in-
13
Industry Insights
one hxed-rale Iong-lern narkel-
lased hnancing soIulions for
infraslruclure.
IncidenlaIIy, anolher uninforned
and unlenalIe, refrain againsl use
of IRS narkel is lhal lhis slralegy
enlaiIs 'lasis risk and 'Iiquidily risk.
Il has leen eslalIished lhal lhere is a
slalislicaIIy signihcanl and posilive
correIalion lelveen one year IRS
rale and one year lank deposil rale
of O.75 vhich viII inprove furlher lo
near perfecl IeveI of O.9O lo 1 once lhis
slralegy is acliveIy engaged in. As
regards 'Iiquidily risk, lanks have
never so far experienced lhis and viII
nol as lheir deposils have grovn ly
18-pIus every year. Indeed, Iarge
corporales, can lhenseIves do il in-
house ly accessing lhe Rupee Inleresl
Rale Svap Markels. As I said lefore,
corporales nusl lreal hxed rale Iong-
lern funding as lhe lase-case, or risk-
neulraI, slralegy. Considering lhal
lhe hve year OIS (Overnighl Indexed
Svap) have lraded aloul 1 lo 1.5
leIov lhe corresponding nalurily
governnenl lond yieIds, corporales
can, and shouId, svap lheir shorl-lern
oaling-rale Ioans inlo hxed rale Iong-
lern Ioans and yel pick up lhe alove
negalive yieId spread, effecliveIy
lorroving Iong-lern funds nuch
nore cheapIy lhan perhaps vouId le
lhe case if lhey vere lo lorrov eilher
fron lanks, or for lhal naller, fron lhe
corporale lond narkel. This is lolaIIy
risk free arlilrage slralegy corporales
can, and nusl, engage in. Of course,
vhen lhis slarls gelling done on a
Iarge scaIe as il indeed shouId, lul has
nol so far happened, such negalive
yieId spreads viII aulonalicaIIy le
arlilraged avay. In facl, CIOs in
corporales nusl roulineIy conpare
lhe lvo hxed rale Iong-lern funding
oplions lo conlinuaIIy assess if lhey
can lorrov hxed rale Iong-lern funds
cheapIy ly lorroving in lhe shorl
lern narkel vhere lhey nighl have
a conparalive advanlage. ul lhe
reverse viz., corporales lorroving
hxed rale Iong-lern and svapping
Ioan proceeds inlo overnighl oaling
rale funds nusl le scrupuIousIy
avoided. Nolhing supporls lhis leller
lhan lhe recenl period of lighlening
cycIe vhich caused overnighl oaling
rales lo go up fron 3.5 in March 2O1O
lo 8.5 in Ocloler 2O11 i.e., effeclive
cunuIalive rise in overnighl inleresl
rales of 5 ! Having said lhal, il is
lolh counler-inluilive, and dislurling,
lo nole lhal sone corporales have
consislenlIy leen 'receiving hxed and
'paying oaling ! Whal lhis neans is
lhal corporales have leen specuIaling
ly courling inleresl rale risk ly paying
'overnighl oaling rale and receiving
'hxed rale. Why I say lhis is for lhe
reason lhal if corporales hrsl lorroved
hxed rale Iong-lern funds and lhen
svapped lhen inlo overnighl oaling
rale, lhen lhey are exposed lo inleresl
rale risk lecause of 5 increase in
inleresl rales. On lhe olher hand, if
lhey specuIale in IRS narkel vilhoul
any underIying exposure in lhe hxed
rale Iong-lern Ioans, lhen lhey viII
olviousIy le paying overnighl and
receiving OIS hxed rales and, lherefore,
lhey Iose lolh on lhe oaling rale side
as aIso on lhe hxed rale side lecause
during lhe sane period, hve year OIS
rales aIso increased, lhough onIy,
ly O.6. We lhus see if lhey have
specuIaled in inleresl rale narkels,
ralher lhan hedge, lhey have Iosl lolh
vays any vhich vay one Iooks al il !
Whal I have said aloul nanagenenl
of rupee inleresl rale risk appIies jusl
as nuch lo oaling rale Lilor-Iinked
Iong-lern foreign currency Ioans as
veII and I vouId, lherefore, slrongIy
connend lo lusiness and induslry lo
go in for inleresl rale svap-enalIed
hxed rale Iong-lern hnancing lolh
in doneslic and foreign currencies.
WhiIe sliII on lhe suljecl of Inleresl
Rale Svaps denoninaled in Indian
rupees, I vouId vish lo address lhe
queslion as lo vhelher counlerparlies
exisl on lhe olher side. My ansver
vouId le, yes lhey do, and, in facl,
one loo nany ! This I say lecause lhe
oulslanding nolionaI principaI anounl
of IRS, as I said lefore, is a vhopping
Rs. 6O lriIIion (aloul 82 of lolaI
lanking assels) (USD 1.14 lriIIion) and
of vhich, dislurlingIy, onIy Iess lhan
2 is accounled for ly lhe reaI seclor
i.e. lusiness cusloners and lhe resl is
accounled for ly specuIalive lrading
of lank deaIers, noslIy foreign and
privale seclor lanks ! In olher vords,
lhe renaining 98 inlerlank exposure
of aloul Rs. 59 lriIIion represenls super-
alundanl/ overvheIning polenliaI
suppIy of counlerparlies as lhe hugeIy
negalive spreads lo C-Secs yieIds onIy
nean hxed-rale receivers far exceed,
and oul-nunler, hxed-rale payers
and, lherefore, if corporales, as naluraI
14
Industry Insights
hxed-rale payers, as I said lefore, cone
in, lhal viII onIy nake lhe hxed-rale
receivers loo happy as lhe addilionaI
denand for paying hxed viII onIy
increase relurns for hxed inleresl rale
receivers in lhe IRS narkel. Thal
lhis represenls polenliaIIy a verilalIe
syslenic hnanciaI risk is anolher
naller lo vhich I have separaleIy,
nore lhan once, cogenlIy aIIuded, lo
no avaiI and, do again, in lhe foIIoving
paragraph, hopefuIIy, lo sone avaiI.
This conpares very poorIy vilh
oulslanding OTC forvard exchange
conlracls, vhere cusloner (reaI seclor)
foreign exchange conlracls accounl
for aloul 4O of lhe oulslanding
conlracls ! This cIearIy highIighls vhal
is referred lo as lhe 'hnanciaI seclor
- reaI seclor inlaIance, vhich vas
lhe cause of lhe Iasl gIolaI hnanciaI
crisis. In facl, lhe silualion here in IRS
segnenl, unIike forex OTC forvard
segnenl, is aInosl gelling lo lhe
poinl vhere lhe IRS narkel, inslead
of leing a neans lo an end of sul-
serving lhe reaI seclor is, lo aII inlenls
and purposes, exisling aInosl enlireIy
for ils ovn sake lo aInosl conpIele
excIusion of lhe needs of lhe reaI
seclor, crealing a nassive 'hnanciaI
seclor-reaI seclor inlaIance !
esides, lhe IRS narkel is fairIy
Iiquid, deep and efhcienl up lo 5 year
5 year nalurily, and vilh lhe righl
poIicy nix, il can easiIy gel so uplo 1O
years and leyond. Ior inlernalionaIIy,
IRS deaIers lypicaIIy, and roulineIy,
nake narkels quoling IRS yieIds as a
nark-up over corresponding nalurily
governnenl lond yieIds. Ior exanpIe,
if a counler-parly vanls lo pay 1O
year hxed, and receive overnighl
oaling, in IRS narkel, a deaIer viII
innedialeIy hedge ly shorling a 1O
year governnenl lond, and invesling
saIe proceeds in overnighl repo
narkel. Hovever, lhis cannol le done
in India for vanl of shorl seIIing and
HTM (HeId lo Malurily) and no MTM
(Marked lo Markel) accounling. As
regards noliIizing Iong-lern pIayers,
Iike pension and insurance funds, inlo
IRS narkel, lhey leing reaI noney
inveslors, vouId nol le a naluraI hl
lo lhe IRS narkel. Lven if lhey do, lo
converl lheir shorl-lern assels (of vhich
lhey viII have hardIy any), inlo Iong-
lern ones, lhey viII nol lake recourse
lo lhe IRS narkel for lhe sinpIe reason
lhal, as I aIso said lefore, lhey viII le
earning 'nore lhan 1OO lasis poinls
'Iess lhan lhe corresponding nalurily
C-Secs. The slock refrain expIaining
lhis aInosl a pernanenl slrucluraI,
lhough quirky, counler-inluilive,
perverse and preposlerous fealure of
lhe Indian IRS narkel is lhal arlilrage,
invoIving receiving hxed on C-Secs,
and paying hxed in IRS, is nol possilIe
lecause of lhe so-caIIed 'lasis risk.
ul lhis is lolaIIy unlenalIe for lhe
sinpIe reason lhal 'lasis risk appIies
jusl as nuch lo 'hedging as il does
lo arlilrage. In olher vords, 'lasis
risk is arlilrage-hedging agnoslic
and, lherefore, il inevilalIy foIIovs
lhal IRS narkel, unIike OTC forvard
exchange narkel, is leing used oul
and oul for specuIalion and nol al
aII even for hedging and, lherefore,
inconlroverlilIy expIains vhy Iess lhan
2 of lhe oulslanding nolionaI principaI
anounl of lhe IRS aIone is accounled
for ly lhe reaI seclor i.e. lusiness
cusloners ! esides, signihcanlIy,
lhis preposlerous fealure of lhe Indian
IRS narkel is anli-lhelicaI lo lhe Iav
of one price, OR, vhich is lhe sane
lhing as no-arlilrage argunenl ! This
underIies lhe lheory and praclice of
any derivalives pricing vaIualion. ul
in lhe case of lhe Indian IRS narkel,
vhal hoIds inslead is lhe Iav of lvo
prices, AND no-arlilrage argunenl
!! On lhis louch slone, lhe IRS narkel
in India is lhen a 'non-derivalive
!!Anolher dranalic, lul reaIislic,
inlerprelalion of lhis phenonenon is
lhal lhere is a super lullIe inaling in
lhe IRS narkel lecause lypicaIIy zero
lo very lighl/narrov, lul sliII posilive,
spreads lo risk free C-Secs inpIy a
lullIe and, lherefore, huge negalive
spreads of riskier IRS lank deaIers
lo risk free C-Secs inpIy a super
lullIe!! Hovever, if lanks and
corporale praclise vhal I have
suggesled, lhe Indian IRS narkel viII
lurn inlo a 'derivalive !!
9. As regards connodily prices,
lusiness and induslry can use
inlernalionaI connodily exchanges lo
hedge doIIar price risk, and doneslic
connodily exchanges lo hedge rupee
price risk. In facl, vhenever sone
connodilies, Iike crude oiI, are in
lackvardalion (lhe fulures price leing
Iover lhan lhe currenl spol price), in
addilion lo luying price proleclion,
lusiness and induslry aIso earn vhal
is knovn as 'roIIing, or 'convenience,
yieId.
1O. y nov, I an sure readers nusl
have gol a fairIy good sense of lhe
reperloire of derivalives lo choose
fron in nanagenenl of hnanciaI risks
lusiness and induslry need lo conlend
vilh day in and day oul. Hovever,
as regards derivalives, I vouId Iike
lo quole IinanciaI Tines CoIunnisl
WoIfgang Munchau and Warren
uffell vho fanousIy descriled
derivalives 'as prolalIy lhe nosl
dangerous hnanciaI producls ever
invenled and 'hnanciaI veapons
of nass deslruclion, respecliveIy. I
vouId leg lo differ lecause, lo ny
nind, lhey are as slrong slalenenls
as saying lhal cars and driving are
nosl dangerous lecause lhey nighl
15
Industry Insights
Iead lo accidenls ! The prolIen is
nol so nuch vilh derivalives, or vilh
cars, for lhal naller, lul vilh hov ve
use lhen !! In lhis conlexl, as nosl
readers are veII avare, lhe inslances
of egregious forex Iosses of hundreds
of crores lo lhousands of crores of
rupees, nore lhan offselling, in sone
cases, lhe nel prohl fron nornaI core
lusinesses, are Iegion and lhe prinl
nedia repIele vilh lhen. These Iosses
arose prinariIy lecause derivalives
vere used ly lusiness and induslry
nol for hedging, lul for specuIalive,
purposes. As reporled in lhe nedia,
huge Iosses vere suslained ly
lusiness and induslry on accounl of
conpIex slruclured and synlhelic, lul
so nuch Iess lransparenl, derivalives.
In olher vords, lusiness and induslry
nusl go in for pIain vaniIIa derivalives
vhich upfronl, lransparenlIy, and
expIicilIy, discIose cosl of hedging
slralegy ralher lhan arcane, conpIex,
synlhelic and slruclured derivalives
vhich canouage risk. As regards
prudenl use of derivalives, lhe louch-
slone lhal lusiness and induslry can
use vilh prohl is lhal any derivalives
slralegy vhich pronises reduclion,
or eIininalion, of hedging cosl,
or pronises enhancing incone, is
inlrinsicaIIy specuIalive and lhe one
lhal invoIves incurring hedging cosl
and pronises no incone enhancing is
inlrinsicaIIy a hedging slralegy. And
as regards convincing lusinesses lhal
over lhe Iong hauI, lhe cosl-lenehl
caIcuIus of hedging is nel posilive,
al ils nosl lasic and fundanenlaI, il
is as nel posilive as lhal of insurance
for crop, earlhquake, heaIlh, properly,
faclory, hre, lhefl, nachinery,
accidenl, elc.
11. As non-hnanciaI lusinesses, unIike
hnanciaI lusinesses Iike lanks, have a
lypicaI Ieverage/Lquily MuIlipIier of
2 lo 3 lines, lheir assels are funded lo
lhe exlenl of 5O lo 33 ly connon
equily sharehoIders and lhe renaining
5O lo 67 ly lank and lond hoIders,
funded lo lhe exlenl of 42 vilh
lank dell and 8 vilh lond hnance
and 55 vilh lank dell and 12
vilh lond hnance, respecliveIy. Il is
signihcanl lo nole lhal lecause of such
lypicaI corporale hnance slruclure
of non-hnanciaI lusinesses (very
Iov Ieverage), gIolaIIy lhere is no
reguIalion and supervision of such
non-hnanciaI lusinesses in lhe sane
sense as reguIalion and supervision
of hnanciaI lusinesses Iike lanks
prinariIy lecause, unIike in lhe case
of lhe forner, any inprudenl and
risky lehavior, on lhe parl of lhe
Ialler, represenls signihcanl risks lo
deposilors and syslenic hnanciaI
slaliIily. The poinl lhal I an naking
is lhal in lhe case of non-hnanciaI
lusinesses, lecause of lhe lypicaIIy Iov
Ieverage, connon equily hoIders lake
lhe luIk of risks and Iosses fron lheir
acls lolh of connission and onission.
UnIike in lhe case of lanks, vhere
acls of connission of sharehoIders,
direclors, lusiness nanagers are eilher
proacliveIy and preenpliveIy fronl-
slopped, or reacliveIy lack-slopped, ly
reguIalors/supervisors save lhe Iallers
ovn acls of onission lhenseIves, lhere
is no such supervisory/reguIalory
supervenlion in lhe case of non-
hnanciaI lusinesses lo nake lhen
praclise lhe looI-kil deIivered in lhis
Speech, polenliaIIy cuIninaling in
lhe inevilalIe consequences of higher
cosls of lolh equily and dell capilaI,
and in exlrene cases, even insoIvency/
lankruplcy ! Hovever, in India, since
lank dell accounls for roughIy up lo
55 of lhe hnancing of assels of non-
hnanciaI lusinesses, lhe paragraphs
1O2 and 1O3 of lhe RIs Second Quarler
Reviev of Monelary IoIicy 2O11-12,
vhich require lhal vhiIe exlending
fund lased and non-fund lased credil
faciIilies lo corporales, lanks shouId
rigorousIy evaIuale lhe risks arising
oul of unhedged foreign currency
exposure of lhe corporales and price
lhen in lhe credil risk preniun,
viII have lhe effecl of deIivering lhe
required chaslising and chaslening,
vilh lanks pricing unhedged hnanciaI
risk exposure of lusinesses inlo credil
risk preniun, provided lhey are
effecliveIy enforced in praclice.
12. SignihcanlIy, lusinesses nol prac-
lising lhe nuls-loIls-vhal-vhy-hov-
vhen reginen, connended in lhis
arlicIe, does nol nake il lheory any-
nore lhan does a palienl nol praclis-
ing a nedicaI praclilioners reginen
nake il lheory. So if lhe palienl does
nol praclise lhe nedicaI praclilioners
reginen, he viII pay lhe price vilh
his delerioraling heaIlh and, in lhe ex-
lrene case, even vilh his Iife. So aIso
viII lusinesses, vhich do nol praclise
lhe nuls-loIls-vhal-vhy-hov-vhen
reginen in lhis arlicIe, viII pay lhe
price vilh nuch higher cosls of dell,
and equily, capilaI and, in lhe exlrene
case, vilh insoIvency/lankruplcy
due lo hnanciaI risks. }usl as in lhe
case of a palienl, cIose reIalions and
friends nay lry, and secure, reginen
praclice, so aIso in lhe case of non-
hnanciaI lusinesses, sharehoIders,
lhrough lheir eIecled direclors, inde-
pendenl direclors and 'aclivisl share-
hoIders on lheir loards, nusl do vhal
lhey can lo praclise lhe nuls-loIls-
vhal-vhy-hov-vhen reginen in lhis
arlicIe. As soneone has said once
ve nake a choice, ve choose ils con-
sequences as veII. So, if lusinesses
choose, vhelher lecause of enornous
pressure fron sharehoIders, or for lhal
naller, lecause of heads-lusiness-
nanagers-vin-and-laiIs-sharehoIders-
As regards commodity
prices, business
and industry can
use international
commodity exchanges
to hedge dollar price
risk, and domestic
commodity exchanges
to hedge rupee price
risk
16
Industry Insights
Iose incenlive slruclure, lo lehave
nol ralionaIIy and nol pIay for lhe
Iong-lern and lake conpIeleIy avoid-
alIe hnanciaI risks, lhey choose lhe in-
evilalIe consequences as veII of leing
lackIashed, and chaslised, ly capilaI
narkels conprising equily and dell
(lolh lond and lank dell narkels).
Such inprudenl lehaviour viII, in
equiIilriun, resuIl in capilaI narkels
exacling higher equily risk preniun
(Iover share price) as veII as higher
credil risk preniun (Iover dell
price). (The Ialler is indeed enjoined
upon lanks ly paragraphs 1O2 and
1O3 of lhe RIs Second Quarler Re-
viev of Monelary IoIicy of Ocloler
2O11. These decade oId inslruclions/
guideIines, originaIIy issued in 2OO1,
vere, nore or Iess, reileraled in 2OO3
and 2OO8 and, of course, again, in lhe
Second Quarler Reviev of Monelary
IoIicy, in Ocloler, 2O11). Therefore, if
lhey choose nol lo praclise, one need
nol feeI conpunclious as lhey sinpIy
viII aIso choose lhe inevilalIe con-
sequences of lheir ovn choice vhich
viII enlaiI nuch higher equily capilaI
cosls and lorroving cosls in lanking
credil and lond narkels, and, in lhe
exlrene case, insoIvency/lankruplcy,
lhus, nol naxinizing, lul nininiz-
ing, and even deslroying, sharehoIder
vaIue and veaIlh.
13. To sun up, such is lhe insidiousness
of risk lhal ils under-pricing is
perceived as Iov, or no risk, and,
lherefore, econonic agenls incIuding
lanks, lusiness and induslry are
caughl unavares and unpIeasanlIy
surprised vhen risk suddenIy
evenluales. Therefore, lo ny nind,
nolhing conveys and expresses lhe
Risk Managenenl nanlra nore
lrenchanlIy lhan lhe foIIoving : }usl
as you nake friends vhen you donl
need lhen, nol vhen you need lhen
and cerlainIy nol afler you need lhen,
so aIso you hedge vhen you donl need
il, nol vhen you need il and cerlainIy
nol afler you need il. ConpIele
inlernaIizalion and ingraining of
lhis hoIislic risk hedging cuIlure,
allilude and lenper ly lusiness and
induslry viII, in equiIilriun, reduce
cosl of lolh dell and equily capilaI ly
reducing voIaliIily of ROL as narkels
viII perceive lhen as nuch Iess risky
and nore safe ! If I have succeeded
in aIerling and sensilizing lhe Iearned
and discerning readers lo lhe IinanciaI
Risk Managenenl inperalive
enough, I viII feeI vindicaled lhal
I have deIivered on ny dharna !
And, I have no doull, if lusiness and
induslry conpIeleIy inlernaIize and
ingrain lhis nanlra and dharna, lhey
viII exenpIify lhe foIIoving fairy laIe
ending viz. And lhey Iived happiIy
ever afler ! IinaIIy, vilh lhe fond
hope lhal I have nol unvillingIy
cone across as ponlihcaling on lhe
nanlra and dharna of IinanciaI Risk
Managenenl, I concIude ny arlicIe
and going forvard vish lusiness
and induslry a lruIy lIissfuI Risk
Managenenl nirvana !
V.K. Sharma
Executive Director
Reserve Bank of India
A career cenlraI lanker and a Menler of lhe Markels Connillee of ank for InlernalionaI
SellIenenls, aseI, SvilzerIand, Mr. Sharna relired as Lxeculive Direclor, Reserve ank of
India (RI), on 31sl Decenler, 2O12. As Lxeculive Direclor, Mr. Sharna vas leen responsilIe
for 11 crilicaI and sensilive Deparlnenls covering such diverse areas as IinanciaI Markels,
Ioreign Lxchange Reserves Managenenl, InlernaI Dell Managenenl, Hunan Resources,
Adninislralion, Currency Managenenl, RuraI IIanning and Credil, IinanciaI IncIusion,
Cusloner Service, Irenises and ReguIalion and Supervision of Urlan Co-operalive anks.
A .Sc. in Ihysics, Iure and AppIied Malhenalics and an M.Sc. in Ihysics, he hoIds an
Advanced Sludies Cerlihcale in InlernalionaI Lcononic IoIicy Research fron KieI Inslilule of
WorId Lcononics, KieI, Cernany and is recipienl of lhe presligious Lord AIdinglon anking
Research IeIIovship and lhe hrsl RI CoIden }uliIee schoIarship for pursuing research and
advanced sludies alroad,
He has had exceIIenl and versaliIe perfornance lrack-record vilh slrong aclion, oulcone,
resuIl and deIivery orienlalion in poIicy naking and execulion.
Mr. Sharna has fornidalIe credenliaIs in IinanciaI and Derivalives AnaIylics and Risk
Managenenl.
SeveraI of his research papers, arlicIes and speeches have leen pulIished in Ieading lusiness
nevs papers, presligious journaIs and ank for InlernalionaI SellIenenl (IS) Revievs.
He has served as Chairnan/Menler/Direclor of severaI inporlanl Connillees/ Working
Croups/Coverning oards/CounciIs/ank oards and represenled RI in various
presligious nalionaI and inlernalionaI fora.
17
Role of Foreign Exchange Risk
Management in Indian Corporate
Performance
The IinanciaI SlaliIily Reporl
pulIished ly Reserve ank of India in
Decenler 2O12 nenlions Lxcessive
voIaliIily in lhe exchange rale nakes il
difhcuIl for econonic agenls lo nake
oplinaI inler-lenporaI decisions. The
econonic agenls, lherefore, need lo
properIy undersland and neasure
lhe nalure of currency risk enledded
in lheir lusiness and use appropriale
derivalive inslrunenls lo hedge
lheir currency risks. ..Iron lhe
infornalion sulnilled ly lanks, il is
olserved lhal a signihcanl porlion of
foreign exchange exposures renained
unhedged in lhe recenl period. This is
especiaIIy disquieling given lhal lhe
exchange voIaliIily has leen higher in
India in conparison lo olher energing
narkel currencies as veII as lhose of
advanced econonies.
The Indian rupee has leen highIy
voIaliIe in lhe recenl pasl driven
ly high lrade dehcil, unsuslainalIe
hscaI dehcil and voIaliIe Ioreign
InslilulionaI Inveslors (III) ovs. As
can le seen fron lhe graph lhal lhe
rupee deprecialed ly 15 fron `49 lo
1 USD lo aloul `56 in }une 2O12, in a
span of 3 nonlhs. Hovever, lhe rupee
apprecialed fron }une IeveI lo aloul
`52.9O in Seplenler 2O12, for a shorl
period, lul noved up lo approxinaleIy
`55 in Decenler 2O12.
Mr. B. A. Prabhakar, Chairnan & Managing Direclor, Andhra ank
The economic
liberalization has
facilitated the
introduction of
derivatives based
on interest rates and
foreign exchange
18
The sleep voIaliIily in lhe rupee
is nol a recenl phenonenon. Such
a lrend couId le olserved fron lhe
exchange rale novenenls fron 2OO5
lo 2OO7 vhen lhe rupee apprecialed
fron `44 IeveI lo `39 IeveI. This again
vas shorl-Iived as rupee deprecialed
conlinuousIy fron Decenler 2OO7 lo
March 2OO9, vhen lhe rupee louched
`51.
The voIaliIily in rupee novenenl
has lroughl in undue hardship lo
econonic agenls in lerns of high
inporl liIIs, increase in lhe effeclive
cosl of foreign currency lorroving,
high Currenl Accounl dehcil and aIso
conlriluling for fueI inalion.
Hov are lhe various econonic agenls
nanaging lhe forex risks arising oul of
voIaliIe rupee novenenls` Lxposure is
one vhere lhe conlracled or projecled
cash ov is uncerlain al lhe nonenl
and depends on lhe vaIue lhe foreign
exchange rales. Lxposures arise in lhe
course of inporls, exporls, lorrovings
or Iending in foreign currency. The
process of idenlifying risks faced ly lhe
hrn and inpIenenling lhe process of
proleclion fron lhese risks ly hnanciaI
or operalionaI hedging is knovn as
foreign exchange risk nanagenenl.
Risk nanagenenl lechniques vary
vilh lhe lype of exposure and lern of
exposure.
The econonic IileraIizalion
has faciIilaled lhe inlroduclion of
derivalives lased on inleresl rales and
foreign exchange. Hovever, lhe use of
derivalives is sliII a highIy reguIaled
area due lo parliaI converliliIily of
lhe rupee. The ralionaI approach lo
nanaging lhe forex risks is lo hedge
lhe exposure lhrough lhe appropriale
hedging inslrunenls Iike forvards,
currency svaps and olher derivalive
inslrunenls. ul Iel us Iook al hov our
corporales have nanaged lhe forex
risks.
When lhe rupee apprecialed
during earIy 2OO7, and louched `39 in
nid 2OO7, exporlers rushed lo look
forvard conlracls seIIing lheir exporl
proceeds of nexl 3 lo 5 years, vilh
lhe expeclalion lhal lhe rupee viII
conlinue lo appreciale disregarding
lhe facl lhal lheir cosl of produclion
vas nol indexed lo foreign currency
novenenls.
Hovever, rupee slarled deprecialing
and ly nid 2OO8, louched `5O IeveI
viping oul nol onIy lhe gains seen in
2OO7 lul lreaking lhe earIier IeveIs.
Lxporlers vho looked derivalive
lransaclions had lo accounl for huge
Iosses, vhich in sone cases viped
oul lheir nelvorlh. Sone of lhese
conpanies lurned oul lo le NIA
lorrovers. Many of lhen queslioned
lhe visdon of lhe lankers in seIecling
such inslrunenls and accused lhen of
nisseIIing lhe derivalives.
We are nov vilnessing nany Indian
Corporales vho have lorroved foreign
currency Ioans - lolh shorl lern and
Iong lern - ICC elc., al allraclive
inleresl rales have kepl lheir exposures
unhedged ignoring lhe currency risks.
The reaI cosl of lorrovings of such
Ioans is nol jusl lhe noninaI rales lul
aIso lhe cosl of hedging lhe lorrovings
for lhe enlire lenor. Il shouId le
ensured lhal lhe prohl & Ioss accounl
of each year reecls lhe econonic cosl
of lorrovings and accounling fuIIy
for lhe risk. IaiIure lo do so vouId
resuIl in highIy voIaliIe earnings of lhe
conpany. To iIIuslrale, if a conpany
lorrovs $ 1 niIIion for hve years al
6 nonlhs LIOR + 4OO lps (4.5O625),
lhe `/$ rale on lhe dale of lorroving is
`55. The conpany accounls for inleresl
equivaIenl of US$ 45O62 each year in
I&L accounl. If lhe rupee depreciales
afler lvo years lo a IeveI of `61, lhe
conpany viII have lo accounl for
lhe exchange Ioss of US$ 6OOOO in lhe
year in vhich lhe deprecialion occurs
pIus lhe noninaI inleresl. This resuIls
in uneven accounling of lhe cosl of
lorrovings.
The foIIoving lalIe gives a Iisl of
conpanies vho had lo accounl for
Iosses arising oul of currency risks.
39
41
43
45
47
49
51
53
55
57
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
19
A CRISIL Research anaIysis of lhe
effecl of lhe rupees sleep deprecialion
on seIecl 42 Nifly conpanies reveaIed
lhal, al an aggregale IeveI, lhese
conpanies reporled foreign exchange
Iosses of aloul `48 liIIion in Q2 of
2O11-12, vhich vas around 8 per
cenl of lheir lolaI IT of `572 liIIion.
The forenosl reason for lhese foreign
exchange Iosses is lhe high IeveI of
foreign currency dell, vhich needs lo
le reporled using lhe cIosing exchange
rale. The cunuIalive foreign currency
dell of lhese conpanies is eslinaled
al `1.5 lriIIion, vhich is around 24 per
cenl of lheir lolaI oulslanding dell,
as per lhe Ialesl avaiIalIe conpany
annuaI reporls. The hedging poIicy
of lhese conpanies aIso pIays a roIe
in delernining lheir foreign exchange
Iosses, as lhe derivalive inslrunenls
are narked-lo-narkel. (The Hindu -
27lh Decenler 2O11)
Il is in lhis lackground lhal RI
in ils IinanciaI SlaliIily Reporl
highIighled lhe syslenic risks arising
oul of unhedged forex exposure. In lhe
Second Quarler Reviev of Monelary
IoIicy unveiIed in lhe Ocloler 2O12,
lhe RI inslrucled anks lo ensure
lhal lheir lorrovers have a oard
approved poIicy on hedging currency
exposures and lhal lhey are adhered
scrupuIousIy.
Role of the Boards in Forex
Risk Management
Many Chief IinanciaI Ofhcers (CIO)
are considering Corporale Treasury
as prohl cenlers and are induIging in
specuIalive aclivilies. Il is line lhal
CIOs undersland lhe inherenl risk
and lhe oards of lhese conpanies
pIay a proaclive roIe in having an
appropriale hedging poIicy in pIace.
The Audil Connillee of lhe oards
shouId ensure inpIenenlalion of lhese
poIicies in Ieller and spiril.
Il is very inporlanl for lhe oards
lo lake inlo accounl faclors Iike size,
Ieverage, Iiquidily and prohlaliIily
of lhe conpany inlo consideralion
vhiIe franing lhe hedging poIicy.
Conpanies vilh Iarge size of laIance
sheel considered as nore credilvorlhy
counlerparlies for forvard or svap
lransaclions, have conpelilive
advanlage in lerns of hedging
charges.
SiniIarIy, corporales vilh highIy
Iiquid assels or high prohlaliIily have
Iess incenlive lo engage in hedging as
lhey are exposed lo a Iover prolaliIily
of hnanciaI dislress. Conlrary,
corporales vilh high Ieverage have
grealer incenlive lo engage in hedging
as il reduces lhe prolaliIily, and lhus
lhe expecled cosl of hnanciaI dislress.
Role of Banks in Forex Risk
Management
anks have leen pIaying a signihcanl
roIe ly exlending lhe required hnanciaI
supporl lo lhe corporales vho are lhe
lacklone for econonic deveIopnenl
of lhe counlry. Of Iale, lhe needs of lhe
corporale seclor are ever increasing in
lhe Iighl of lheir gIolaI operalions and
lhey expecl lanks lo provide advisory
services on appropriale hedging
slralegies. anks have a hduciary roIe
in advising lhe corporale vilh suilalIe
hedging inslrunenls afler anaIyzing
lhe risk prohIe of lhe conpany.
UnforlunaleIy, il has leen olserved
in lhe pasl lhal lhe lanks have soId
derivalive producls soIeIy vilh a
viev lo earn prohls al lhe cosl of
lhe conpanies. Il has leen videIy
reporled in 2OO7-O8 lhal lanks offered
derivalive producls lo lhe conpanies
vho did nol undersland lhe enledded
risks of lhese producls. LvenluaIIy lhis
has Ied lhe corporales lo look huge
Iosses. In lhe process nany corporales
have laken lhe anks lo lhe courls and
sulslanliaI lank funds are sluck in
Non Ierforning Assels.
Companies incurred huge forex losses
No Company
Fnrcx GaIn / Lnss (`MI!!Inn)
2007-08 2008-09 (Q1 tn Q3)
1 }SW SleeI Lld 371 -8152
2 }uliIanl Organosys Lld 1O4O -4132
3 Tala Molors Lld 1778 -6326
4 Tala SleeI Lld 5973 -7756
5 SuzIon Lnergy Lld 44 -4345
Scurcc. CR|S|| Rcscarcn Rcpcr|
20
Industry Insights
In lhe alove lackdrop, vhiIe
appraising lhe credil requirenenls,
anks shouId faclor lhe unhedged
forex risks and lhe credil risk preniun
are hxed accordingIy. The forex risks,
if nol addressed suilalIy ly lhe
corporales, nay evenluaIIy Iead lo
credil risk lo lhe lanks. Thus, il is aIso
lhe responsiliIily of lhe lanks lo ensure
lhal lhe lorroving conpanies shouId
have a oard approved hedging poIicy
in pIace and lhe poIicy guideIines are
adhered lo scrupuIousIy.
Forex Risk Management-
Accounting Standards
Il is evidenl fron lhe corporale
hislory lhal lusinesses vilh superior
governance praclices generale leller
vaIue lo slakehoIders. ConverseIy,
lhe coIIapse of high prohIe conpanies
denonslrales lhe facl lhal lhey
faiIed lo adopl prudenl accounling
and governance praclices in lheir
operalions.
Accounling Slandards-11 (AS-11)
requires conpanies lo creale Mark-
lo-Markel (MTM) provisions for lheir
exposure lo foreign currency Ioans.
Hovever, Ioans avaiIed for vorking
capilaI purposes aIone vouId shov
up in lhe Irohl & Loss accounl
and lhose used for crealing assels/
capilaI expendilure vouId hnd pIace
in lhe laIance sheel. This slandard
enalIes lhe conpanies lhal have
lorroved foreign currency Ioans lo
luy or creale an assel lo capilaIize lhe
exchange difference on forex Ioans lo
lhe cosl of lhe assel inslead of laking
lo Irohl & Loss accounl. Though lhe
exlanl guideIines provide reIief lo lhe
conpanies vho are crealing assels
ly avaiIing foreign currency Ioans,
il is inviling delale especiaIIy in lhe
rupee deprecialion environnenl as il
resuIls in reporling of inaled prohl
hgures ly lhese conpanies. Therefore,
il caIIs for innediale allenlion of
lhe ReguIalor and olher associaled
professionaI lodies lo revisil lhe
exisling Accounling Slandards for
furlher inprovenenl lo ensure good
corporale governance and lo prevenl
polenliaI syslenic risk.
Way forward
The increased foreign lrade has leen
necessilaling lhe corporales lo deaI
vilh nuIlipIe currencies vhich are
fraughl vilh currency risks on accounl
voIaliIe forex narkel and lhis lrend is
IikeIy lo slay in lhe ensuing years aIso.
Thus, il is essenliaI for corporales lo
inpIenenl syslenalic hedging aclion
pIan so lhal any adverse novenenls in
currency rales viII nol cause pressure
on lheir nargins and prohlaliIily.
The corporales can lake lesl hedging
decisions onIy vhen lhe risk nanagers
acknovIedge lhal narkel novenenls
are unprediclalIe. Hovever, a hedge
shouId aIvays seek lo nininize risk
lul shouId nol represenl a ganlIe on
lhe direclion of narkel prices.
The adoplion of proper hedging
poIicy enalIes lhe corporales lo
oplinize lheir resources and aIso
faciIilales lhen lo focus on lhe
core lusiness for ils conpelilive
advanlage. In lhis scenario, lhe Iorex
Risk Managenenl poIicies of lhe
corporales have lo renain slrong and
have lo le slriclIy adhered lo prolecl
lhe inleresls of aII lhe slakehoIders and
in prevenling syslen risks.
It is essential
for corporates to
implement systematic
hedging action plan
so that any adverse
movements in
currency rates will
not cause pressure
on their margins and
prntabI!Ity
B A Prabhakar
Chairman & MD
Andhra Bank
Shri A Iralhakar has leen appoinled as Chairnan & Managing Direclor of Andhra
ank. He assuned ofhce on O2.O1.2O12. Irior lo joining in Andhra ank, he vas Lxeculive
Direclor of ank of India fron 15.1O.2OO8 lo 16.12.2O11. LarIier Shri A Iralhakar vas
CeneraI Manager of ank of aroda.
A Craduale in Connerce and Charlered Accounlanl, Sri A Iralhakar slarled his
lanking career vilh ank of aroda in 1977 as a Direcl Recruil Ofhcer. He has vide
exposure lo areas of Corporale Credil, Iorex/Treasury and InlernalionaI anking
vilh a slinl in Uniled Kingdon as CeneraI Manager and Chief Lxeculive Ofhcer of
ank of aroda fron ApriI 2OO4 lo }anuary 2OO8. He aIso vorked in Zanlia during
1989 lo 1993.
Covernnenl of India appoinled Shri A Iralhakar as Chairnan of InpIenenlalion
and Moniloring Connillee on Audil Syslens & ModeI Audil ManuaI in IulIic
Seclor anks.
21
Industry Insights
T
here are knovn knovns,
lhere are lhings ve knov lhal
ve knov. There are knovn
unknovns, lhal is lo say lhere are
lhings lhal, ve nov knov ve donl
knov. ul lhere are aIso unknovn
unknovns - lhere are lhings ve do
nol knov ve donl knov
The lasic poinl of Iorner US
Secrelary of Defence DonaId
RunsfeIds ofl quoled connenl viII
resonale vilh forex deaIers. AuslraIian
econonisl }ohn Quiggin noled lhal .
lhe consideralions he refers lo provide
lhe case for leing very caulious in
going lo var. And for conpanies in
India, lhe fog of var environnenl in
forex narkels viII le an increasingIy
inporlanl parl of lheir connerciaI
aclivily, vilh caulion lhe IikeIy
Iodeslone of approach.
}usl as dealh and laxes are lhe lvo
conslanls of Iife, forex narkels have
lecone lhe poIar opposile in lerns
of voIaliIily. }usl vhen ve vere
gelling used lo lhe Rupee al 44 lo lhe
US DoIIar in }uIy 2O11, and frelling
aloul lhe consequences of il headed
lovards 3O, ve vere lIindsided ly
a sudden reversaI of lrend vilh lhe
Rupee dropping sharpIy al hrsl, and
lhen quile precipilousIy Novenler
onvards. We acluaIIy shouId nol have
leen very surprised. Lcon 1O1 laughl
us lhe Covered Inleresl Iarily (CII)
lheory of equiIilriun exchange rales,
vhich is a no-arlilrage condilion
under vhich inveslors are indifferenl
Divining the Rupees future
Mr. Saugata Bhattacharya and Mr. Abhishek Upadhyay
Senior Vice Iresidenl and Senior Manager, usiness and
Lcononic Research, Axis ank
Just as death and
taxes are the two
constants of life, forex
markets have become
the polar opposite in
terms of volatility
22
Industry Insights
lelveen inleresl rales on lank
deposils in lvo counlries. SinpIy pul,
lhis says lhal lo nake reaI relurns in
a high inleresl (and presunalIy high
inalion econony) jusl as unallraclive
as in a Iov inleresl one, lhe exchange
rale (in spol and forvard narkels) of
lhe high inleresl rale nusl depreciale
enough.
e lhe reaIily as divergenl fron
lheory as il nay, vhy has forex
lecone so inporlanl for India` Indias
econony has very rapidIy lecone nore
inlegraled vilh lhe gIolaI one (Charl
2). If one adds aII lhe foreign ovs
inlo and oul of India, lolh currenl and
capilaI accounl, lhe sun has increased
fron 5O percenl of CDI in 2OO1-O2
lo 116 percenl in 2OO8-O9. Of course,
lhis ralio had dipped lo 99 percenl in
lhe aflernalh of lhe hnanciaI crisis,
lul has again gone up lo 11O percenl
in 2O11-12. We gel inpacled lhrough
nuIlipIe channeIs: lolh exporls and
lrade hnance, exlernaI connerciaI
lorrovings, porlfoIio ovs,
renillances, and olhers. Lxporls have
lecone a fairIy inporlanl conponenl
of Indias econonic aclivily. Indias
(nerchandise and services lrade) nov
accounl for 24 percenl of CDI, vhiIe
lhal of China (vhich ve inslincliveIy
leIieve is nuch nore lrade dependenl)
is nol nuch higher al 33 percenl.
This arlicIe focuses on lhe USD
INR pair, leing lhe nosl inporlanl
anong lhe increasingIy Iarge laskel of
lraded currencies in India. Many of lhe
readers are aIso IikeIy lo have lo lake
a viev on olher currencies, najor or
ninor, depending on lhe requirenenls
of lheir lransaclions, lul lhe direclions
of novenenl viII le delernined lo
a Iarge exlenl ly lhose of lhe najors.
Hov has India done on lhe forex
fronl` The Rupee has renained an
underperforner for nuch of 2O12
conpared lo our LM peers, reecling
lhe underIying inlaIances of exlernaI
denand (see Charl 1).
Whal vere lhe nain drivers for
forex deveIopnenls in lhe pasl
coupIe of years` TalIe 1 shovs lhe
conparalive slanding of Indias nacro
fundanenlaIs reIalive lo a seIeclion of
our conpelilors for capilaI inovs.
WhiIe India has cerlainIy oulperforned
on grovlh, lhe increasing vuIneraliIily
of ils lvin dehcils - hscaI and currenl
accounls - reIalive lo our peers
coincided vilh gIolaI deveIopnenls
(Luropes sovereign dell voes erupled
during lhis period)
Whal do lhe slars foreleII on forex`
If, as lhe joke goes, lhe onIy funclion
of econonic forecasling is lo nake
aslroIogers Iook respeclalIe, currency
forecasling is orders of nagnilude
riskier. We can lul laIk of principIes
and assign prolaliIilies lo polenliaI
oulcones. The lask is nov nade
aII lhe nore onerous, since inveslor
senlinenl viII pIay a najor roIe, in
lhe shorl lern doninaling econonic
fundanenlaIs, and gIolaI capilaI ovs
have increased in lhe pasl fev nonlhs,
as a gIolaI risk-on characlerislics gel
under vay. As lhe RI descriles il, lhe
econony is al a lipping poinl, and
can ip eilher vay depending on
poIicy reforns and inpIenenlalion of
de-lollIenecking neasures. There are
lroadIy lvo, inlerreIaled drivers of lhe
Rupee: (a) laIance of paynenls ovs
and (l) novenenls of lhe US DoIIar
versus olher najor currencies. The
forner is lhe doninaling faclor.
efore ve louch on lhe fundanenlaI
drivers of lhe Rupee, is lhe Rupee
under- or over-vaIued, and viII lhere
le a reversion lo lhe nean, in olher
vords is lhere an equiIilriun vaIue
lo vhich lhe Rupee viII reverl if
econonic condilions are slalIe` There
is IillIe cIarily. The slandard gauge for
delernining is equiIilriun is lhe
ReaI Lffeclive Lxchange Rale (RLLR),
lased on lhe CII lheory nenlioned
earIier (Charl 3). This needs lo le
inlerpreled vilh caulion, since lhe
choice of lhe reference lase period
lends lo lias lhe signaI. In addilion,
lhe period over vhich lhe reversion
lo lhe nean happens is proIonged
and uneven. Wilh lhese caveals, il is
evidenl fron Charl 3 lhal lhe Rupee
Iooks lo le cIose lo sone nolion of
average. Hovever, lhere are lvo
crilicaI assunplions underIying lhe
CII lheory: (a) capilaI noliIily and
(l) sulslilulaliIily of doneslic and
foreign assels, incIuding lransaclions
cosls. These inperfeclions creale lhe
polenliaI of currencies diverging fron
presuned, nolionaI equiIilria over
Iong line periods.
Coning lack lo lhe fundanenlaIs,
Indias laIance of paynenls is IikeIy
lo inprove in 2O13-14, lolh via a
slalIe Currenl Accounl Dehcil (CAD)
and higher capilaI ovs. olh IY12
and IY13 have (or viII IikeIy have)
experienced negalive laIance of
paynenls ovs. The currenl accounl,
in parlicuIar,
23
Industry Insights
One of lhe faclors vhich delernine
lhe USD INR is lhe novenenl of lhe
USD againsl lhe gIolaI najor (see
Charl 4). A risk on environnenl usuaIIy
neans funds exiling US Treasuries
and seeking risk assels. WhiIe lhere
is a IikeIihood of voIaliIily in lhe USD
LUR, lhere is IillIe doull lhal lhe USD
viII veaken againsl Lnerging Markel
currencies, incIuding lhe INR. WhiIe
lhis is good for lhe Rupee, il aIso
unforlunaleIy neans lhal prices of
nany gIolaI connodilies (parlicuIarIy
crude oiI), vhich are denoninaled
in USD, viII lend lo increase. This
adverseIy affecls Indias nerchandise
lrade dehcil, and lends lo neulraIize
sone of lhe gains in lhe currency.
So vhal are lhe chances of risk-on
environnenl energing` As of nov, lhe
gIolaI econony Iooks as if lhe vorsl
in lerns of calaslrophic voIaliIily is
lehind us. Crovlh in lhe deveIoped
narkels viII le veak, as lhey go
lhrough lhe deIeveraging process and
credil grovlh renains suldued. This
viII inevilalIy Iead lo a capilaI exodus
lo fasler groving energing narkels.
If India is perceived lo le a good risk-
revard lel, il viII allracl signihcanl
inovs.
In concIusion, lhe Rupee is IikeIy lo
renain quile voIaliIe. The direclion can
ip any vay, depending on lhe vay
poIicy changes evoIve. The liggesl
evenl risk, of course, is lhe Union
udgel, lo presenled al end-Ielruary,
vhich viII dehne lhe lrajeclory of lhe
Rupee. Indias grovlh is loo slrong an
allraclion for lhe vasl pooIs of gIolaI
capilaI in quesl of relurns. Civen lhe
direclion of reforns inilialed ly lhe
Covernnenl, lhere is a slrong chance
of lhe RI reciprocaling ly easing
nonelary poIicy, vhich viII le grovlh
posilive.
80
85
90
95
100
105
110
115
120
125
130
Oct-10 Mar-11 Jul-11 Dec-11 Apr-12 Aug-12 Jan-13
CNY - China
BRL- Brazil
MYR - Malaysia
INR - India
KRW - Korea
TRL - Turkish
90
95
100
105
110
115
120
Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12
REER (6 country trade based, 2004-05=100)
Mean+ 1SD
Mean- 1SD
(April'04: USDINR - 43.9)
(July'12: USDINR -
53.05)
47%
56%
50%
53%
60%
67%
79%
97%
114% 116%
99%
106%
110%
0%
30%
60%
90%
120%
FY93 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12
Total external flows as % of GDP
Trade flows % GDP
Financial flows % of GDP
Chart 1: Comparative performance of Rupee
and other EM currencies
Chart 3: Real Effective Exchange Rate
(REER) nf INR
Chart 2: Indias integration with the
global economy
Indias growth is too
strong an attraction
for the vast pools of
global capital in quest
of returns
24
Industry Insights
38
42
46
50
54
58
62
70
75
80
85
90
95
Oct-08 Oct-09 Oct-10 Oct-11 Oct-12
DXY Dollar Index USD/INR (RS, Inverted)
Chart 1: Comparative performance of Rupee and
other EM currencies
Abhishek Upadhyay
Senior Manager and
Economist, Axis Bank
Saugata Bhattacharya
Senior Vice President and Chief
Economist at Axis Bank
Mr. Alhishek Upadhyay is a Senior Manager and Lcononisl al Axis
ank, India. He earned his Maslers in usiness Lcononics al lhe
Universily of DeIhi and vas previousIy enpIoyed vilh lhe CIolaI
Markels research lean al ICICI ank, India. He has aIso vorked as a
Senior Researcher al lhe Inslilule for Indian Lcononic Sludies, Tokyo,
}apan
Mr. Saugala hallacharya is Senior Vice Iresidenl and Chief Lcononisl
al Axis ank..
He vas a nenler of lhe RIs Working Croup on Operaling
Irocedures of Monelary IoIicy and lhe Iinance Minislry Sul-Croup
on Lslinaling Ioreign Savings for lhe Approach Iaper for lhe 12lh
Iive Year IIan (2O11).
He vas previousIy vilh UniIever in India and vilh Infraslruclure
DeveIopnenl Iinance Conpany (IDIC). He vas educaled al lhe DeIhi
SchooI of Lcononics and Oxford Universily. He is a coIunnisl for
lhe IinanciaI Lxpress and is on lhe oard of India Today Lcononisls
(ITL).
Russia 2.9 10.0 0.7 5.3 97.6
Brazil 4.2 5.2 -2.5 -1.5 65.4
India 8.1 9.2 -7.8 -2.3 72.5
S.Africa 2.7 7.0 -2.7 -4.9 52.0
Mexico 1.5 4.4 -2.9 -0.8 42.4
Turkey 3.6 8.1 -2.5 -6.0
Korea 3.5 3.4 1.6 2.3 32.4
China 10.5 3.7 -1.2 6.5 22.7
US 0.6 2.2 -8.5 -3.8 86.9
UK 0.1 3.2 -7.3 -2.1 64.5
Japan -0.1 -0.2 -7.2 3.3 206.0
Fiscal balance
as % of GDP
CAD as a % of
GDP
Govt debt as
% of GDP
GDP
yoy%
Inflation
yoy%
Table 1
Tnc ticus arc |nc au|ncrs cun an c nc| ncccssari|q rccc| |ncsc cf |nc ins|i|u|icn |c unicn |ncq arc aff|ia|c.
25
Industry Insights
W
e leIieve lhal lhe
nacro nanagenenl of
Indias rupee hinges
on nainlaining sufhcienl forex
reserves and keeping exlernaI dell
reIaliveIy Iov. Afler aII, India runs
a Iarge currenl accounl dehcil lhal
has lo le funded ly capilaI inovs.
Civen lhe uclualions in capilaI
ovs in our uncerlain vorId, il is
crilicaI lo nainlain sufhcienl forex
reserves lo fund any sudden capilaI
oulov. In recenl years, lhe inporl
cover (ie, nonlhs of inporls lhal
lhe RIs IX reserves can fund) has
haIved lo 7 nonlhs - Iasl seen in
1996 - fron 14 nonlhs in 2OO8. This
has resuIled in a sharp deprecialion
of lhe Indian rupee. In response,
ve expecl lhe RI lo recoup IX
reserves lo slaliIize lhe INR in lhe
coning 1-2 years. In our viev, lhe
INR viII nol slaliIize liII lhe RI
reluiIds IX reserves sufhcienlIy lo
assuage inveslor conhdence.
Three phases of RBI policy
The RIs IX poIicy can le lroken
inlo lhree phases: ninlIe 2-vay
operalions lo luiId fx reserves even
al lhe cosl of a reIaliveIy veak INR
(liII 2OO4), suslained fx accunuIalion
lo prevenl undue apprecialion (2OO4-
O7), and a preference for apprecialion
lo hghl inporled inalion even al lhe
cosl of luiIding fx reserves
(2OO9-11). This, in lurn, has puIIed
lhe inporl cover dovn lo lhe 7 nonlhs
Iasl seen in lhe nid-199Os. As a resuIl,
lhe RI viII IikeIy need lo focus lack
on reluiIding IX reserves Iike lhe Iale
199Os.
The macroeconomics of managing the rupee
Mr. Indranil Sen Gupta, India Lcononisl, ank of Anerica MerriII Lynch
INR will not
stabilize till the RBI
rebuilds FX reserves
sufpclent| to assuage
lntestor conpdence
26
Industry Insights
Till 2004: Buying FX to
build reserves
We expecl lhe RI lo reverl lo lhe
pre-2OO4 praclice of luying as nuch
IX as possilIe during periods of capilaI
inovs and seIIing as IillIe as possilIe
during capilaI oulovs. In lhe 199Os,
lhe RI used lo luiId IX reserves as
insurance cover lo prolecl lhe laIance
of paynenls fron a 1991-lype crisis.
Covernor inaI }aIan and Depuly
Covernor Reddy vouId luy as nuch
IX as possilIe during capilaI inovs
and seII as IillIe as lhey couId during
capilaI oulovs. They aIso oaled
lhe 5-year Resurgenl India onds in
1998 afler lhe Asian crisis and India
MiIIenniun Deposils in 2OO1 afler lhe
dolcon lusl lo raise US$5ln each. As
lhese gueriIIa lype laclics luiIl up IX
reserves, inproved inveslor conhdence
Ied lo capilaI inovs and ly exlension,
apprecialion.
2005-07: Buying FX to stem
appreciation
The RIs exchange rale poIicy shifled
gears ly lhe nid-2OOOs. SurpIus capilaI
inovs, allracled ly lhe discovery
of lhe India grovlh slory, legan lo
push up lhe INR. This had aIIoved
Cov Reddy lo anass US$113ln lo
prevenl undue INR apprecialion. The
silualion changed dranalicaIIy afler
lhe Lehnan crisis vhen lhe RI had
lo seII US$3Oln lo hghl conlagion.
CapilaI oulovs legan lo puII dovn
lhe INR. In response, lhe RI had lo
seII IX lo prevenl a run on lhe INR
in 2OO8 and end-2O11. We do nol
see a quick relurn lo lhe easy gIolaI
Iiquidily years of 2OO5-O7.
2009-11: Strong INR at cost
of FX reserves
During lhe period of 2OO9-11
anpIe IX reserves prevenled any
queslions aloul lheir adequacy. This
provided Cov Sullarao lhe scope lo
appreciale lhe INR in 2HO9-1H11 lo
hghl inporled inalion even al lhe
cosl of nol luying IX reserves. This,
in lurn, has puIIed dovn lhe inporl
cover dovn lo 199Os IeveIs. }usl as
inporlanlIy, foreign inslilulionaI
inveslor (III) inveslnenl in dell has
cIinled lo US$4O+ln fron hardIy
US$5ln in 2OO8. Il is lhus onIy naluraI
lhal lhe RIs exchange rale poIicy
viII have lo reverl lo 199Os node of
reluiIding IX reserves lo conforl
inveslor conhdence lefore lhe INR
can appreciale.
Cyclically high current
accnunt dccIt rcmaIns a
challenge
A najor chaIIenge viII le a cycIicaIIy
high currenl accounl dehcil (TalIe
1). This IargeIy reecls a coupIing of
Iov gIolaI grovlh and high gIolaI
Iiquidily. India sees a doulIe vhanny
lecause ils key exporls - especiaIIy,
engineering exporls - are hurl ly poor
grovlh. Al lhe sane line, oiI inporls
have gone up vilh high oiI prices
junping on easy Iiquidily. We do nol
expecl lhe currenl accounl dehcil lo
narrov lo our eslinaled suslainalIe
2.5 of CDI liII 2O15 vhen US
econonisls expecl grovlh lo revive
sufhcienlIy for lhe Ied lo slarl lo hike
rales. Il is for lhis reason ve expecl lhe
38.0
42.0
46.0
50.0
54.0
58.0
M ar -
00
M ay-
01
J ul -
02
S ep-
03
Nov-
04
J an-
06
M ar -
07
M ay-
08
J ul -
09
S ep-
10
Nov-
11
I NR/ USD
Chart 1: Forex reserve management key to stabilize Rupee
27
Industry Insights
INR lo ruIe slrucluraIIy veak for lhe
nexl 2-3 years.
Higher FX reserves,
stronger INR
We do nol expecl lhe IX narkel
lo gel luIIish on INR unliI lhe RI
has recouped IX reserves. Afler aII,
lhe RIs exlernaI dell indicalors are
leginning lo Iag RIC IeveIs. The
RI viII need lo luy US$9Oln if il is
lo repIenish lhe inporl cover lo even
9 nonlhs. }usl as inporlanlIy, lhe IX
narkel viII aIso fear lhal lhe INR nay
see disproporlionale Iosses in case lhe
US DoIIar shools up in risk off. TalIe
2 leIov shovs lhal lhe RIs exlernaI
indicalors are leginning lo Iag RIC
IeveIs. Againsl lhis lackdrop, ve
expecl lhe RI lo:
luy IX/relire forvards (of -
US$14ln) if lhe INR slaliIizes
al Rs52/USD IeveIs vilh lhe
US DoIIar sellIing al 1.3O/euro,
and
Defend lhe INR al Rs56/USD -
IeveIs if lhe USD appreciales
lo 1.2Os/USD in a loul of risk-
off.
4
6
8
10
12
14
16
18
FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12
Import cover
Months
Chart 2: Import cover lowest since FY96
Tab!c 1: Cyc!Ica!!y hIgh currcnt accnunt dccIt tn pcrsIst
Item FY10 FY11 FY12 FY13 Q2 FY12 Q2 FY13
Currenl Accounl -38.4 -46.O -78.2 -75.5 -18.9 -22.3
of CDI -2.8 -2.7 -4.2 -4.1 -4.2 -5.4
Trade laIance -118.4 -13O.6 -189.8 -18O.5 -44.5 -48.3
- Lxporls 182.2 25O.6 3O9.8 313.O 79.6 69.8
- Inporls 3OO.6 381.2 499.6 493.5 124.1 118.2
o/v OiI inporls 87.1 1O6.1 155.6 154.O
InvisilIes 8O.O 84.6 111.6 1O5.O 25.6 15.6
o/v incone fron forex reserve 5.9 7.O 7.O 7.O
CapilaI Accounl 52.7 62.1 67.8 71.O 19.6 23.9
Ioreign inveslnenl 5O.4 39.7 39.2 36.O 5.3 16.6
- IDI 18.O 9.4 22.1 18.O 6.5 8.9
- III+ 32.4 3O.3 17.2 18.O -1.2 7.7
anking capilaI 2.1 5.O 16.2 16.O 7.O 5.5
- NRI deposils 2.9 3.2 11.9 12.O 2.8 2.8
Shorl lern credil 7.6 11.O 6.7 12.O 2.9 4.1
LCs 2.8 12.5 1O.3 5.O 5.3 1.2
LxlernaI assislance 2.9 4.9 2.3 2.O O.3 O.1
Olhers -13.O -11.O -6.9 O.O -1.3 -3.6
OveraII laIance 14.3 16.1 -1O.4 -4.5 O.3 O.5
Meno
RI's forex inlervenlion -2.7 1.7 -2O.1 -13.5
Scurcc. R8|
28
Industry Insights
Higher nostro balances
can fund US$5-8bn FX
intervention
Can lhe RI reaIIy luy IX nov
vilhoul disrupling lhe IX narkel`
Yes, as high lanks noslro IX laIances,
al a conforlalIe US$2O+ln (incIusive
of forvards), shouId cushion lhe
inpacl of lhe RIs IX purchases lo
sone exlenl. SecondIy, lhe currenl
accounl dehcil is peaking off al aloul
4 of CDI. IinaIIy, lhe lunching of
lank and corporale IX paynenls of
US$6.5ln due in Seplenler-Ocloler
are nov lehind us.
The Rupees Dilemma
We are seeing a cIassic Irisoners
DiIenna-lype gane in lhe Indian IX
narkel in vhich lhe vorsl oulcone
of veak INR and Iover IX reserves is
pIaying oul. In our viev, lhe onIy vay
oul is for lhe RI lo luy IX lo provide
lhe narkel lhe conforl lhal il can fend
off conlagion.
1. RBI buys FX, market buys INR:
We lhink lhe lesl soIulion sureIy
viII le for lhe RI lo accunuIale IX
and lhe IX narkel lo luy INR. The
RI shouId lhen achieve ils lvin
oljeclives of slaliIizing lhe IX narkel
and reducing 'inporled inalion
pressures. The IX narkel couId easiIy
nake 5-1O and ils gains vouId le
reIaliveIy leller prolecled if lhe RI
is in a slronger posilion lo prolecl
lhe INR fron conlagion. The INR did
indeed see such a happy coupIing of a
rising INR reaI effeclive exchange rale
(RLLR) and IX reserve accunuIalion
in lhe 2OOOs.
2. RBI doesnt buy FX, market sells
INR: Whal is unforlunaleIy happening
nov is preciseIy lhe reverse. Nol onIy
has lhe RI nol leen alIe lo luy IX,
lul il has acluaIIy had lo seII US$14ln
Table 2: Indias external indicators are trailing BRIC levels
Pre-Crisis Crisis Current
IX reserves
(as of
CDI)
Inporl
cover
IX
reserves/
Shorl-lern
LXD
IX
reserves
(as of
CDI)
Inporl
cover
IX
reserves/
Shorl-
lern LXD
IX
reserves
(as of
CDI)
Inporl
cover
IX
reserves/
Shorl-lern
LXD
Brazil 13.2 17.9 2.9 14.7 22.4 3.O 16.O 17.9 3.O
Russia 36.7 25.7 4.9 35.9 27.5 6.6 26.O 17.3 7.4
India 25.O 14.4 3.9 21.5 11.1 2.7 15.9 7.1 2.1
China 43.7 2O.3 12.5 48.1 3O.2 15.9 4O.7 21.4 7.6
4
6
8
10
12
14
16
18
FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12
Import cover
Months
Chart 2: Import cover lowest since FY96 We think the best
solution surely will
be for the RBI to
accumulate FX and
the FX market to
buy INR. The RBI
should then achieve
its twin objectives
of stabilizing the FX
market and reducing
'Impnrtcd' In0atInn
pressures
29
Industry Insights
forvard. arring occasionaI louls of
oplinisn, nosl of vhich have ended
in grief, lhe IX narkel has soId lhe
INR for lhe Iarge parl since end-2O11. If
lhis conlinues, lhe INR vouId lecone
a slory of Iover lops and deeper
lollons.
3. RBI buys FX, market sells INR:
So, vhy doesnl lhe RI luy IX lo
conforl lhe narkel` ecause ve
lhink lhal lhe narkel nay seII INR
due lo a IX shorlage and furlher fueI
inalionary pressures. In Seplenler-
Novenler 2O11, lhe sleep 13.4 INR
deprecialion vas, afler aII, aggravaled
ly paynenl of lunched up dues of
aloul US$5ln lo Iran for oiI inporls.
A1O deprecialion lypicaIIy lransIales
inlo 1OOlp of inalion.
4. RBI doesnt buy FX, market buys
INR: Why doesnl lhe narkel luy
INR lo reassure lhe RI` ecause il
IikeIy leIieves lhal luIIish INR lrades
vouId gel slopped oul if lhe RI
reaIIy slarls luying. And if il doesnl
recoup IX reserves, lhe INR couId
veII see disproporlionaleIy Iarge
Iosses lhan olher currencies in case
lhe USD shools up in a sudden risk-
off. Afler aII, lhe INR has deprecialed
19.3 - second onIy lo raziI - since
Seplenler 2O11.
Sen Gupta, Indranil
Economist India
IndraniI Sen Cupla joined ank of Anerica MerriII Lynchs Asia Iacihc
Lcononics lean as India econonisl in }uIy 2OO7.
IndraniI earIier served lhe Reserve ank of India as a slaff econonisl for a
decade, anaIyzing nonelary condilions and forecasling inalion. He vas aIso
co-convenor of ils Advisory Croup on Insurance ReguIalion.
IndraniI hoIds a Maslers degree in Lcononics fron Nev DeIhis }avaharIaI
Nehru Universily. He is lased in Munlai.
30
Industry Insights
O
ver lhe Iasl fev years,
inporlance of Ioreign
Lxchange Risk Managenenl
for any corporale operaling in India
or eIsevhere has leen rising. One
of lhe prinary reasons for lhe sane
is an increase in lhe frequency and
nagnilude of econonic crises lhal hil
lhe vorId and drive up lhe voIaliIily
in IX narkels.
The frequency of hnanciaI crises has
increased in recenl years. Lvery line a
crisis hils lhe IX narkels, lhe narkels
lend lo gel driven ly evenls ralher
lhan fundanenlaIs for a period of
line. This nakes il exlreneIy difhcuIl
for anyone lo predicl lhe IX narkel
novenenls or even have a viev on
lhe sane.
Asian Conpanies have leen
severeIy inpacled ly lhis increased
voIaliIily in IX Markels.In sone cases
lhe inpacl leing as high as 5O of Nel
incone. This inpacl cIearIy lrings
oul lhe inporlance of nanaging lhis
hnanciaI risk for conpanies given lhal
nosl conpanies in India operale vilh
LITDA nargins of aloul 1O-2O
and ve have seen IX narkel svings
of siniIar nagnilude vhich can vipe
oul lhe nargins for lhese conpanies.
The piclure leIov shovs a variely
of risks faced ly a corporale in
lhe course of ils lusiness. Sone
are inlernaI and sone exlernaI. A
corporale is acluaIIy in lhe lusiness of
laking sone risks lhal il nay le nore
conpelenl lo nanage eg. lusiness
risks, slralegic risks, operalionaI risks
elc. The process of risk nanagenenl
slarls vilh underslanding lhe
inlerpIay lelveen lhese various risks
Mr. Vipul Chandra, Managing Direclor, Corporale
SaIes & Slrucluring , Soulh Asia Markels
Asian Companies
have been severely
impacted by this
increased volatility
in FX Markets
31
Industry Insights
and accepling lhe facl lhal risks are nol
reaIIy eIininaled lul jusl lransforned
fron one forn lo anolher using cerlain
hedge inslrunenls.
Interplay between Financial and
Business risks: TypicaIIy a corporale
is conpeling vilh nany peers (lolh
doneslic and inlernalionaI) in ils Iine
of lusiness. Any IX hedges laken ly
il have lo slarl vilh a projeclion of ils
expecled IX exposures inlo lhe fulure.
These projeclions are lhenseIves
lased upon cerlain assunplions aloul
lhe slale of ils lusiness perfornance
in fulure. A decision laken ly lhe
corporale lo hedge aII of ils IX
exposures for nexl 2 years couId Ieave
il in an under/over hedged posilion
depending on hov ils lusiness
acluaIIy perforns v/s lhe projeclions.
This under/over hedging couId ilseIf
pose risks lo lhe corporale. In olher
vords, nanaging lhe IX risks, acluaIIy
lransforned lhe risks inlo a lusiness
risk. If a conpany is very conpelenl in
nanaging ils lusiness risks and very
unconforlalIe in nanaging IX risks,
il nay decide lo foIIov lhe alove
slralegy.Mosl conpanies so far have
leen approaching IX risk nanagenenl
as a viev lased approach i.e. laking
hedges vhen lheir viev on narkel
indicales lhal lhe narkel couId nove
againsl lheir underIying exposure.
This slralegy nay vork in a slalIe
narkel environnenl lul in an evenl
driven narkel environnenl, is IikeIy
lo le quile un-prediclalIe and hence
risky. Hence, for nosl conpanies il
vouId le nore prudenl lo foIIov
a nore scienlihc and syslenalic
approach. We presenl leIov one such
approach lhal is videIy used ly nany
Iarge corporales.
Risk Management Process
This can le divided inlo 5 nain sleps
as iIIuslraled in lhe hgure lo lhe righl.
1. RIsk IdcntIcatInn : This is lhe
nosl inporlanl slep in lhe process.
The corporale has lo slarl ly Iisling
oul lhe various risks faced ly il and
aIso undersland lhe inlerpIay lelveen
ils underIying lusiness dynanics
and ils hnanciaI risks. Il has lo Iook
al hidden IX risks eg. Conpelilion
fron inporled goods (creales Iinkages
lelveen ils seIIing price and IX rales),
reIialiIily of ils lusiness cash ov
forecasls, possilIe lechnoIogy changes,
pricing pover (aliIily lo pass on price
increases lo cusloners or suscepliliIily
lo denands for price culs ly cusloners
in case of a favoralIe narkel nove) elc.
If il has exposures lo nuIlipIe narkel
faclors Iike connodilies, inleresl rales,
IX elc lhen il is aIso inporlanl lo Iook
al correIalions lelveen lhen.
Al lhis slage, il has lo aIso decide
on lhe hedging horizon il is going lo
operale vilh i.e. vhal vouId le lhe
line frane lasis vhich il viII lake ils
risk nanagenenl decisions. This is
again Iinked lo lhe underIying lusiness
cycIe. Over a period of line lusinesses
can adapl lo changing exlernaI
environnenl, hence il is inporlanl for
lhe corporale lo evaIuale ils underIying
lusinesss adaplaliIily line frane.
If lhe corporale has lhe aliIily lo
adjusl ils prices every six nonlhs,
lhen il needs lo nanage ils risks for
6 nonlhs horizon. On lhe olher hand
if a corporale is in an induslry lhal
operales on Iong lern connilnenls,
ils hedging horizon has lo le
necessariIy Ionger. In addilion, lhe facl
lhal a corporale is a going concern and
a parliaI hedge can aIvays snoolhen
oul lhe adaplalion process. This aIso
needs lo le laken inlo consideralion.
Ior nosl nanufacluring conpanies
lhus, a 2-3y hedging horizon vouId
lypicaIIy vork.
2. RIsk QuantIcatInn: The nexl slep
afler Risk idenlihcalion is lo quanlify lhe
risk inlo a nore oljecliveIy neasuralIe
and easiIy underslood forn. This
enalIes lhe conpany nanagenenl
lo have a connon Ianguage lelveen
hnance and lusiness lo discuss and
undersland risks as veII as faciIilale
risk nanagenenl decision naking ly
lhe loard. Depending upon lhe nalure
and conpIexily of lhe corporales
exposure and ils size il can choose lo
use one of lhe leIov 3 nelhods for risk
quanlihcalion:
a. Iaclor Sensilivily Approach: Ior
a one unil change in lhe IX rale,
vhal is lhe change in lhe LITDA
for lhe corporale. This approach is
good for quanlifying risk exposure
lo a singIe narkel faclor or a group
of independenl narkel faclors
hovever il does nol lake inlo
accounl any correIalions and aIso
lhe IikeIihood of such a nove.
l. Scenario luiIding: This approach
invoIves draving up a fev pIausilIe
scenarios of narkel environnenl
and lhen quanlifying lhe inpacl on
LITDA. Hovever lhe prolaliIily
of any of lhe scenarios happening
is again a viev on narkels.
c. CIaR or LaR approach: Using a
Monle CarIo sinuIalion lo sinuIale
aII lhe narkel faclors lhe conpany
is exposed lo (laking inlo accounl
lheir correIalions) over lhe hedge
horizon and lhen quanlifying lhe
95 conhdence IeveI (lhis couId
aIso le 99 or 9O) Larnings al
Risk (LaR) or Cash IIov al Risk
(CIaR). This approach heIps
95% CFaR
Forecasted
Firm Val ue
Fi rm Value Rs MM
32
Industry Insights
quanlify lhe risks faced ly lhe
conpany inlo a singIe nunler lhal
is easy lo undersland and nanage.
Hovever given lhal il is a slalislicaI
neasure, lhis Ieaves open lhe risk
lhal al Ieasl 5 of lhe lines lhe risk
couId le higher lhan predicled.
This has lo le laken inlo accounl in
lhe nexl slep vhen fornuIaling lhe
risk slralegy.
3. Setting Risk Strategy: Al lhis slage
il is inporlanl for lhe conpanys loard
lo decide on lhe risk slralegy i.e. hov
nuch IX risk lhey are conforlalIe
vilh (keeping in nind lhal any sleps
lo niligale risk aIso neans giving
up lhe opporlunily lo lenehl fron a
favoralIe narkel nove). Il is inporlanl
for lhe loard lo reaIize lhal a hedge
lransaclion, if il is a proper hedge i.e. is
offselling an exisling risk posilion, can
never nake or Iose noney or in olher
vords a hedge lransaclion cannol le
evaIualed in isoIalion and needs lo le
evaIualed in lhe conlexl of lhe overaII
risk posilion of lhe conpany lo see
vhelher il has nanaged lo achieve lhe
risk niligalion oljeclive. Hovever lhe
lrade-off lelveen Risk and opporlunily
is nol evenIy laIanced eg. If a conpany
is operaling on an LITDA nargin of
15 and ils LaR over a 1y period cones
oul lo le 3O ly lhe alove neasure
lhen il is exposed lo lhe risk of leing
viped oul. Hence for lhis conpany,
reducing ils exposure lo IX is nore
inporlanl lhan Iooking al lhe possilIe
upside lhal nay cone aloul in case
lhe narkel noves in ils favor.
This effecliveIy dehnes lhe Risk
Capacily of lhe corporale i.e. a IeveI
of LaR il cannol ever exceed no naller
lhe foregone opporlunily.
Hovever given lhal lhere couId
le 5 of cases vhere lhe LaR couId
exceed lhe eslinaled nunler, lhe
loard nay choose lo dehne a lighler
land vhich ve caII as Risk ToIerance.
This vouId le lhe largel sel for lhe
corporale lreasurer lo achieve. He/
She in lurn couId sel narrover hedge
oljeclives for nanaging on a day
lo day lasis. This nechanisn for
dehning a risk slralegy is expIained in
lhe hgure leIov.
4. Hedging Strategy and Alternatives
evaluation: Once lhe largel is sel ly
lhe loard, lhe lreasurers jol is lhen
lo oplinize lhe hedging slralegy lo
achieve lhe largel al oplinun cosl.
This vouId nean hedging sone of lhe
exposure irrespeclive of narkel vievs
lo al Ieasl cone vilhin lhe risk capacily
and lhen dynanicaIIy nanaging lhe
hedge ralios lo oplinize lhe risk and
cosl. Ior exanpIe lhe hedge slralegy
nay le lo nainlain a hedge ralio of
nininun 3O of lhe lolaI exposure
for lhe hedge horizon vhich couId
le increased depending on narkel
vievs lo 7O or any olher nunler
in lelveen. The dislrilulion of lhe
hedges over lhe hedge horizon and
choice of hedging inslrunenls Iike
forvards, oplions, svaps elc. couId
aIso le driven ly narkel vievs and
accounling consideralions.
5. Review and Re-balancing : Civen
lhe alove consideralions of inlerpIays
lelveen lusiness and hnanciaI risks,
a slalic hedge progran i.e. a passive
hedge progran is as risky as no
hedging. Hence il is inporlanl for
lhe conpany lo evaIuale ils lusiness
environnenl, changing narkel
condilions and novenenls of narkel
faclors ilseIf lo dynanicaIIy reviev
and relaIance ils hedging slralegy.
This is lhe 5lh and hnaI slep of lhe risk
nanagenenl process.
Accounting and Risk
Management
Whal ve have discussed so far is
focused on nanaging lhe econonic
risks faced ly a corporale due lo ils
exposure lo IX rales. Hovever, hedges
pul on lo nanage such econonic
exposures nay nol aIvays quaIify
as hedges under lhe accounling
ruIes. This lhen poses an addilionaI
chaIIenge for lhe corporale lreasurer
vherein a hedge progran pul in pIace
lo nanage Ionger lenor econonic risk
nay ilseIf inlroduce cerlain anounl of
accounling I&L voIaliIily due lo lhe
non-quaIifying hedges leing suljecled
lo MTM lrealnenl for accounling.
One of lhe reasons vhy accounling
consideralions have lecone nore
inporlanl in hedging decisions is
lhal inveslors do nol appreciale
earnings voIaliIily arising fron faclors
oulside lhe nain lusiness. Hovever,
33
Industry Insights
apparenl alsence of accounling risk
does nol necessariIy nean 'no-risk.
Lven in cases vhere hedge accounling
is adopled, lhe accounling friendIy
resuIl nay Iead lo lhe voIaliIily
gelling parked lenporariIy in lhe
aIance Sheel (lhal vouId olhervise
reside in lhe earnings). AII lhal hedge
accounling heIps in is lo nalch off
lhe exposures vilh lhe hedges vhere
a cIear reIalionship is visilIe. The
sane resuIl couId aIso le achieved
ly lhe inveslor if lhe inveslor vere lo
anaIyze lhe laIance sheel a lil nore
in deplh and undersland lhe hedging
slralegy of a conpany nol foIIoving
hedge accounling. Iocusing onIy on
Accounling risk nanagenenl nay
Ieave lhe corporale open lo Ionger
lern inpacl of econonic risks.
IundanenlaIIy, lhere is no singIe
ansver in lerns of vhich of lhese
risks shouId le given priorily over
olher, lul lhere couId le a possilIe
niddIe palh approach vilh respecl lo
lhe decision naking process. Ior any
exposure, il nay le prudenl lo slarl
vilh idenlifying lhe correcl econonic
hedging decisions. Iosl lhis, one
couId expIore if lhe alove hedging
decision vouId creale any adverse
accounling resuIls. If nol, lhen il is
an ideaI silualion and one shouId go
ahead vilh lhe hedging. Ior cases
vilh polenliaI accounling issues,
lhe corporale lreasury nay vanl
lo allenpl quanlifying lhe adverse
accounling oulcone. The polenliaI
scenarios can le pul up lo lhe senior
nanagenenl / loard of direclors
for naking a conscious choice. Al
lhis slage, one can evaIuale vhelher
lhe polenliaI econonic lenehls of
lhe hedging decision oulveigh lhe
polenliaI adverse accounling resuIls. A
conpanys aliIily lo expIain lhe alove
decision lo inveslors viII aIso pIay a
roIe al lhis slage. The alove process
vouId ain al ensuring lhal lhere are
No Surprises lo senior nanagenenl
and lo sharehoIders arising fron lhe
hedging decisions. There are a fev
gIolaI conpanies lhal have laken a
conscious decision lo nark lo narkel
aII lheir hedges and sinpIy expIain
lhis lo lheir inveslors.
Vipul Chandra
Managing Director
Corporate Sales & Structuring -
South Asia Markets
VipuI heads lhe Corporale SaIes & Slrucluring lusiness for Cili
India-Sulconlinenl lased oul of Munlai. He has leen a parl of lhe
Markels group in Cililank India for lhe Iasl sixleen years and has
vorked in various areas Iike Ioreign Lxchange, Derivalives SaIes &
Slrucluring. efore noving inlo his currenl roIe, VipuI vas heading
lhe Derivalive Slrucluring lusiness for Cili India Sulconlinenl vhere
he vas responsilIe for designing nev producls and risk nanagenenl
slralegies for corporale cIienls.
VipuI conpIeled his acheIors degree in LIeclronics Lngineering fron
DeIhi CoIIege of Lngineering lefore going in for an MA fron IIM
CaIculla. Iosl lhal he joined lhe lank in operalions lefore noving lo
Treasury Ironl Ofhce.
34
Industry Insights
Introduction
Recenl crisis has cIearIy highIighled
lhal Indian econony is no Ionger
isoIaled fron gIolaI econony. India Inc
has enjoyed lenehls of gIolaIizalion in
forn of nev narkels for lheir goods/
services, access lo nev lechnoIogy,
cheap sources of rav naleriaIs & nev
sources of capilaI lul il exposes lhen
lo risk of foreign exchange novenenl.
In pasl lvo years, Indian Rupee (INR)
has noved fron Rs 44 lo Rs 57 againsl
US DoIIar (USD) grealIy inpacling
prohlaliIily & conpeliliveness of
Indian conpanies gIolaIIy . A nunler
of corporales vhich reIied upon forex
denoninaled projecl hnance for selling
up green heId projecls or lrovn heId
expansion projecls have aIso seen
lheir projecl cosls soaring and naking
sone of lhe iniliaI projeclions for lhe
projecl unvialIe. As per CrisiI reporl,
in jusl one quarler viz. Q2IY12 lhe
forex Iosses lrinned 8 of lhe Nifly
conpanies prohl anounling lo Rs
48 liIIion. During lhal period lhese
Nifly conpanies had cunuIalive
foreign currency dell of aInosl Rs
1.5 lriIIion. More recenlIy in Q1IY13,
as per CapilaIine, 167 conpanies
reporled Ioss of Rs 13 ln on foreign
exchange lransaclions since rupee
deprecialed ly 9.4 againsl USD.
This incIudes MTM Iosses on dell,
lesides foreign exchange Iosses fron
olher lransaclions, such as higher
oulov for lank Ioans. Such high
quanlun of Iosses has leen vilnessed
Mr. Himanshu Kaji, |xccu|itc Dircc|cr, |c|uciss |inancia| Scrticcs |imi|c
Ministry of Corporate
Affairs has taken the
cognizance of high
rupee volatility and
has permitted Indian
companies to capitalize
ropt/|osses on |ong
term foreign borrowings
due to exchange rate
uctuatlon
35
Industry Insights
ly Iarge conpanies lhal are supposed
lo le sophislicaled and have eIalorale
lreasury deparlnenls. Iron lhis one
can easiIy deduce lhe cunuIalive risk
exposure & inpacl on snaII & nediun
size enlerprises.
Minislry of Corporale Affairs has
laken lhe cognizance of high rupee
voIaliIily and has pernilled Indian
conpanies lo capilaIize prohl/Iosses
on Iong lern foreign lorrovings due
lo exchange rale uclualion. This has
provided reIief lo nany corporale on
shorler lern lul in no vay addresses
lhe core issue of nanaging foreign
exchange risk.
Risk Awareness
Lxchange rale novenenl does nol
aIvays Iead lo Iosses for lhe conpanies.
In facl a Iarge nunler of conpanies
have reporled exceplionaI prohl in
Q2IY13 due lo favoralIe novenenl
in rupee (5.25 apprecialion againsl
USD). Lol of corporale Iured ly such
gains do nol hnd foreign currency
novenenl as risk lo lheir lusiness.
So il is inperalive for lhe conpanies
lo recognize lhal lheir slrenglh Iies in
lheir core lusiness and nol in laking
lels on foreign exchange. Cains in
lhe pasl due lo favoralIe currency
novenenl vouId nol le repealalIe &
are in no vay indicalion of lhe fulure.
eing avare of lhe risk is hrsl slep lo
efhcienl risk nanagenenl & Iong lern
suslainaliIily of lhe conpany.
AII conpanies are exposed lo a
variely of risks on a daiIy lasis lul
nol aII risks nay le required lo le
acled upon. Conpanies have lo
lake conscious decision vhelher lo
acliveIy nanage risk or lo Iive vilh
lhe risks since il nayle inherenl vilh
lheir lusiness/nay have negIigilIe
inpacl/cosl of nanagenenl nay
le loo high. To enalIe such decision
naking, conpanies nusl delernine
risk exposure, prolaliIily & inpacl
on naleriaIizalion and if il needs lo
le nanaged lhen lhey have lo dehne
risk nanagenenl pIan lased on lhe
avaiIalIe nechanisn.
Risk Management Strategies
Risk Transfer Strategy
The conpanies nay choose lo do
aII lhe lransaclions in onIy doneslic
currency and lherely lransfer lhe risk
conpIeleIy lo lhe counlerparly. The
slralegy nay le quile sinpIe lul is
highIy inpraclicaI given INR is nol
fuIIy converlilIe. So nosl of lhe lines
il vouId le difhcuIl for lhe conpanies
lo inpIenenl lhis slralegy.
Risk Avoidance Strategy
The conpanies nay choose lo do
lusiness in lhe nanner lhal al nel
IeveI lhere is no hnanciaI inpacl
due lo currency novenenl. This
can le achieved ly having nalched
currency for cash ov, for assel-
IialiIily/revenue-expense elc. Like lhe
previous slralegy, il is nol praclicaI
for lhe conpanies lo dehne lusiness
slralegy conslrained ly risk slralegy.
Hovever il can le used lo nininize
lhe risk exposure. A naluraI hedge is
one of lhe lesl defense nechanisn in a
conpanys risk nanagenenl slralegy
and shouId le acliveIy pursued lo lhe
exlenl avaiIalIe.
Risk Mitigation Strategy
Hedging lhrough derivalive
inslrunenl is nosl praclicaI lul
reIaliveIy conpIex soIulion for lhe
conpanies. ul lefore laking hedging
decision, lhe corporales nusl le
avare of lhe Iinilalion lhal exisls in
lhe Indian currency narkel. IresenlIy,
Corporale can hedge lheir exposure
ly lransacling on lhe exchanges or
enlering inlo over lhe counler (OTC)
conlracls. olh nelhods have lheir
pros & cons vhich nusl le evaIualed
ly lhe conpanies vhiIe dehning risk
nanagenenl pIan.
Hedging through Exchanges
Indian exchanges provide
slandardized fulure conlracls in
USD-INR, LUR-INR, CI-INR &
}IY-INR for 12 conseculive nonlhs,
oplion conlracls for USD-INR for 3
conseculive nonlhs & 1 quarlerIy
conlracl. These conlracls are cash
sellIed lased on lhe RI reference
rale on lhe expiry dale. Trading on
exchange provides lenehls of price
lransparency, conhrned sellIenenl,
Iov lransaclion cosl, veII reguIaled &
cIearIy dehned conlracl cIauses. ul
il renoves exiliIily provided ly lhe
cuslon nade conlracl lhal exisls in lhe
OTC narkel.
NornaIIy lhis vouId have leen
lhe preferred node for hedging for
lhe corporale lul for lhe prolIens
lhal exisls in lhe Indian narkel.
There is nol enough Iiquidily in lhe
narkel for lhe conlracls olher lhan
lhe USD-INR conlracls. Lven in USD-
INR conlracl, lhe Iiquidily is quile
Iov for lhe conlracls vilh nalurily
leyond 3 nonlhs. This Iinils lhe price
discovery & aIso nakes il difhcuIl for
36
Industry Insights
lhe conpanies lo exil lheir posilions
vilhoul laking haircul. The Iiquidily
in oplions conlracl is even nore
alysnaIIy Iov. No oplion conlracls
are avaiIalIe for LUR-INR, CI-INR
& }IY-INR pair on exchanges.
Iurlher Ionger daled conlracls
are nol avaiIalIe on lhe exchanges lo
enalIe lhe corporales lo hedge lheir
Ionger lenure risk exposure. Hedging
Ionger lern risk exposure ly shorler
lenure conlracl on exchanges exposes
conpanies lo lasis risk.
These conslrainls inhilil lhe aliIily
of lhe corporales lo effecliveIy hedge
lheir risk on exchanges.
Hedging through OTC
contracts
Corporale nay choose lo enler inlo
derivalive conlracls vilh lhe lanks lo
hedge lheir foreign currency exposure.
OTC conlracls can le laiIor nade
lased on lhe needs of lhe corporales.
AIlernalives are avaiIalIe lo hedge
Iarger speclrun of currency pair &
Ionger lern risk exposure in OTC
narkel lherely avoiding lasis risk for
lhe conpany. Iurlher il aIso provides
addilionaI inslrunenl in forn of
currency svaps lo hedge foreign
lorrovings. Such inslrunenls are nol
avaiIalIe lhrough exchanges.
The alove nenlioned lenehls are
narred ly lhe queslionalIe narkel
praclices. There is no lransparency in
pricing of such OTC conlracls across
lanks vhich nakes lheir evaIualion
difhcuIl for lhe corporale. SiniIarIy
lhe conlracl cIauses aIso vary lelveen
lanks, lelveen conlracls exacerlaling
lhe conpanys issue of delernining
righl conlracl for lhen. Iurlher lhese
cIauses are oflen one sided vhich are
delrinenlaI lo lhe conpanies and
aInosl difhcuIl lo enforce al lhe line of
crises. AIso in alsence of lransparenl
pricing, il is very difhcuIl for lhe
conpanies lo exil lhe conlracls vilhoul
haircul. SiniIarIy, il is nol possilIe lo
verify lhe narked lo narkel charged
on lhe lransaclions. Mosl of lhe lanks
charge MTM Iosses lo lhe conpanies
lul do nol aIIov lhen lo vilhdrav/
offsel lhe MTM gains againsl nargins
vhich can Iead lo Iiquidily issues for
lhe conpanies.
In lhe pasl, lhere have leen
nunerous inslances of nis-seIIing of
lhe forex derivalive conlracls ly lhe
lanks lo conpanies. Nave corporale
vere soId conpIex derivalive producl
vilhoul leing avare of lhe dovnside
risk ly lhe aggressive lankers. Such
conpanies are nov averse lo lhe
concepl of hedging especiaIIy lhrough
OTC lransaclions.
Right Risk Strategy:
WhiIe reconnending risk
nanagenenl slralegies for Indian
corporale, lhere cannol le one size hls
aII soIulion. ased on lhe lenehls &
Iinilalion nenlioned for each slralegy,
lusiness size & needs, conpanies can
seIecl lhe righl slralegy for lhen.
Lven lhough Indian conpanies have
faced doulIe vhanny vilh sIoving
econony & voIaliIe rupee, lhe adoplion
of lhese risk slralegies has leen disnaI
since lheir Iinilalion overrides lhe
lenehls provided ly lhen. Nol
nuch can le done lo overcone lhe
Iinilalions inherenl lo lhe slralegy
lul in Indian conlexl nany of lhe
Iinilalions are due lo unavaiIaliIily
of appropriale inslrunenls/ narkels
vhich can le addressed ly nuIliIeveI
slrucluraI reforns. Righl inslrunenls &
deveIoped narkel, if provided, vouId
go Iong vay in reIieving lhe prolIens
of lhe conpanies vilh respecl lo
foreign currency novenenl.
Recommended Exchange
related reforms
Lov Iiquidily on lhe exchanges
across lhe exisling conlracls is one
of lhe key concerns for lhe Indian
conpanies. This can le easiIy soIved
ly pernilling lanks lo lrade on lhe
exchanges. They can acl as narkel
naker & inprove lhe Iiquidily across
lhe conlracls/across lhe currencies.
Iurlher Ionger daled conlracls
can le inlroduced on lhe exchanges
lo aIIov conpanies lo hedge lheir
Ionger lenure currency exposure. This
aIong vilh increased Iiquidily on lhe
exchange vouId le of greal heIp lo
conpanies Iooking for inslrunenls lo
hedge lheir risk.
Low liquidity on the
exchanges across the
existing contracts
is one of the key
concerns for the
Indian companies
37
Industry Insights
Conlracls across vider speclrun
of currency pairs can le provided on
lhe exchanges. Though lhe Iiquidily in
such conlracls vouId le Iov, il vouId
al Ieasl offer sone direcl nechanisn
for lhe conpanies lo hedge lheir risk.
Recommended OTC related
reforms
anks shouId le encouraged lo
nake lheir pricing lransparenl and
lo slandardize lhe conlracls across
induslry. Nunler of reguIalions have
aIready leen inpIenenled lo prevenl
nis-seIIing lo conpanies. anks can
lake nore proaclive roIe in educaling
conpanies aloul foreign exchange
risk & lhe lechniques avaiIalIe lo
niligale lhen. Il is inperalive for
lanks lo insliII conhdence lack in
lhe conpanies vilh respecl lo foreign
derivalive conlracls. This can le done
ly inproving lheir discIosure praclices
& crealing hnanciaI risk avareness.
Conclusion
Alove nenlioned reforns, if
inpIenenled, vouId aIso grealIy
enhance lhe capaliIilies of Indian
corporales lo effecliveIy nanage
lheir Iorex Risks and al lhe sane
line vouId aIso decrease size of lhe
Iarge offshore narkels. This vouId
enhance lhe conlroI of lhe cenlraI
lank on Indian Rupee vhich couId
uIlinaleIy curl Rupee voIaliIily in
Ionger lern.
Himanshu Kaji
Executive Director,
Edelweiss Financial
Services Limited
Mr. Hinanshu Kaji, Lxeculive Direclor, LdeIveiss IinanciaI Services Liniled
A Charlered Accounlanl vilh a Iosl Craduale DipIona in Securilies Lav, Mr. Hinanshu
Kaji has over lvo decades of diverse experience in lhe hnanciaI services space. In addilion
lo his responsiliIilies as Lxeculive Direclor, Mr. Kaji conlinues lo le Croup Chief Operaling
Ofhcer nanaging Iinance, Risk, Operalions, TechnoIogy, Covernance, Adninislralion,
Inveslor ReIalions and ConpIiance al lhe LdeIveiss Croup.
His earIier assignnenls incIude leing an inveslnenl lanker al ICICI Liniled and a slinl al
his faniIy lusiness of lroking. During lhe Ialler, he vas parl of a seIecl group lhal pIayed
a key roIe in lhe corporalizalion and lhe de-nuluaIisalion of lhe onlay Slock Lxchange
(SL) -- lhe oIdesl slock exchange in Asia.
38
Industry Insights
Mr. Baby K P, Ass| Gcncra| Managcr, |ccra| 8an|.
T
he posl rellon Woods era
of free-oaling currencies
and econonic IileraIizalion,
has lroughl lhe vorId cIoser and
inlernalionaI lrade has lecone
lhe Iife-Iine for lhe very survivaI of
nalions. Ioreign Lxchange Trade voI-
unes have nov hil nore lhan 4 lriIIion
USD per day. Il is aII sel lo grov and
lurn lrisk during lhe years lo cone.
CIolaIizalion vhich cane on lhe
heeIs of IileraIizalion has opened up
innense opporlunilies for lusiness
houses in India lo reach oul lo greener
paslures in vorId narkels lo lecone
gIolaI lraders or nuIli-nalionaI
corporales. On naking lhe vorId
lheir pIayground, lheir inveslnenls,
assels, IialiIilies, funding, revenues
and cash ovs gel denoninaled in
nuIlipIe currencies. These expose
lhen hovever lo enornous foreign
exchange risks.
WiId svings in exchange rales
inpacl lhe vilaIs of a conpany and
uIlinaleIy lhe narkel vaIue of ils
equily. LslalIishnenl of a rolusl
and prudenl foreign exchange risk
nanagenenl franevork is essenliaI for
corporale houses lo enjoy lhe fruils of
gIolaIizalion vilhoul lurning hands.
The cash ovs, lollon Iines and nel
vorlh of nany SMLs and Corporales
vere hil hard ly lhe voIaliIily in lhe
foreign exchange rales vilnessed in
recenl nonlhs. The resuIlanl credil
risk lorne ly lhe hnancing lanks
has pronpled RI lo cone oul vilh
In life, as in chess,
forethought wins.
Cnar|cs 8ux|cn
39
Industry Insights
direclions lo lanks for noniloring
lhe unhedged forex exposures of lheir
lorrover consliluenls.
Foreign Exchange Risk
Management framework
Ioreign exchange risk nanagenenl
invoIves lhe foIIoving key aclivilies:
idenlifying exposures and risks,
forecasling rale novenenls,
neasuring, noniloring and reporling
of risks and conlinuousIy enpIoying
appropriale niligalion looIs. Ior
lhis Corporales shouId have a sound
franevork vilh a lIend of hunan
experlise and lechnoIogy driven looIs.
Crealer lhe exposure of a conpany,
lhe leller il vouId le if forex risk
nanagenenl is handIed ly a dedicaled
corporale lreasury independenl of ils
core lusiness. Il viII le ideaI if lhe
lesl praclices of risk nanagenenl are
foIIoved ly lhe Treasury under lhe
cIose oversighl of lhe Risk Connillee.
IdcntIcatInn nf cxpnsurcs
and exchange rate risks
Idenlihcalion of a hrns forex
exposures and lhe lypes of exchange
rale risks lhe hrn is exposed lo shaII le
lhe hrsl slep lovards inpIenenlalion
of lesl praclices. Idenlihcalion of
exposure invoIves underslanding risk
sources and lhe proporlion of lusiness
lhal is dependenl on forex, currencies
invoIved, linings of paynenls/
vaIualion, naluraI hedges avaiIalIe
elc. Ioreign exchange risks can le
cIassihed as foIIovs:
Transaclion risk is lhe inpacl of 1.
adverse currency rale novenenls
on lhe vaIue of foreign currency
denoninaled receivalIes and
payalIes forning parl of a conlracl
enlered inlo ly lhe lusiness.
TransIalion risk is lhe risk 2.
associaled vilh lhe faII in vaIue
of foreign sulsidiaries vhen
lheir hgures are lransIaled lo lhe
currency of lhe parenl conpany
vhiIe consoIidaling hgures inlo
lhe conpanys nasler laIance
sheel. TransIalion risk is neasured
ly lhe exposure of nel assels of lhe
foreign sulsidiaries lo polenliaI
currency rale novenenls.
Lcononic risk represenls lhe 3.
risk lo a hrns presenl vaIue of
fulure cash ovs (and lherely
lhe narkel vaIue of lhe hrn) on
accounl of adverse exchange rale
uclualions.
Conlingenl exposure arises on
lidding for foreign projecls, negolialion
of foreign conlracls or foreign direcl
inveslnenls, lhe oulcone of vhich
cannol le predicled.
Forecasting exchange rate
movements
Afler idenlihcalion of exposures and
risks invoIved, a lusiness has lo lry and
forecasl lhe exchange rale novenenls
across appropriale horizons. The
forecasls shouId le lased on rolusl
assunplions and caIIs for a fair idea of
lhe faclors affecling currency exchange
rales.
Factors affecting exchange
rate
Currency exchange rales are IargeIy
dependenl on lhe denand and suppIy
faclors. The foIIoving are najor faclors
inpacling currency exchange rale.
Movement of Capital: When lhere is
a good inov of foreign capilaI oving
lo lhe enhanced inveslors conhdence
in Indian Markel, lhe denand for
Indian Rupee lecones high againsl
ils foreign counlerparls Ieading lo
apprecialion of Rupee. ConverseIy
ighl of foreign capilaI fron India,
depreciales rupee.
Interest Rates: AcluaI or expecled
rise in inleresl rales in a currency nay
allracl foreign currency inveslnenls,
resuIling in apprecialion of lhal
currency.
Inalion for a shorl lern nay
resuIl in inov of foreign funds in
anlicipalion of increase in inleresl
rales and Iead lo apprecialion of lhe
reIaled currency. Hovever, if inalion
persisls for a reIaliveIy Ionger period,
purchasing pover of noney viII
gel reduced, lherely veakening lhe
currency.
Current account position: Rise
in laIance of lrade dehcil resuIls in
increased denand for foreign currency,
lherely Ieading lo deprecialion of
doneslic currency. In India, increasing
inporl of oiI is lhe najor cause of
videning lrade dehcil.
Public debt: Nalions vilh Iarge
pulIic dells and dehcils are Iess
allraclive lo foreign inveslors.
Increasing pulIic dell nay inpacl
sovereign dell raling indicaling
increase in sovereign credil risk.
IoIilicaI slaliIily and prospecls for
econonic grovlh are aIso signihcanl
faclors affecling lhe novenenl of
foreign exchange rales. Iaclors Iike
naluraI caIanilies are olviousIy
oulside lhe scope of forecasling.
40
Industry Insights
MuIlipIicily of faclors and dynanisn
inherenl in such faclors nay al lines
render lhe prediclions incorrecl. The
prolaliIily of devialion fron projecled
rales increases vilh lhe projeclion
horizon. Hence forex nanagenenl
cannol le Iiniled lo prediclion of
fulure rale novenenls. Yel vhal Lx
U.S. Iresidenl Lisenhover once said is
reIevanl here: |n prcparing fcr |a|||c |
natc a|uaqs fcun |na| p|ans arc usc|css,
|u| p|anning is inispcnsa||c.
Measurement of risk
VaIue al Risk (VaR), dehned as lhe
naxinun eslinaled Ioss lhal can le
incurred on a porlfoIio over a speci-
hed period al a given conhdence IeveI,
is lhe nosl connonIy used risk nea-
surenenl looI. HisloricaI sinuIalion,
variance-covariance nodeI and Monle
CarIo sinuIalion are lhe connonIy
used VaR nelhods. HisloricaI sinu-
Ialion is lhe sinpIesl nelhod, vhich
uses hisloricaI dala on currency rale
novenenls and underIying faclors for
risk eslinalion. Hovever, VaR nea-
sure is inuenced ly Ienglh of eslina-
lion period and appIicalion of veighls
for differenl periods. The variance-co-
variance nodeI assunes nornaI dislri-
lulion of currency relurns and Iinear
reIalionship of porlfoIio conponenls.
Though lhe VaR caIcuIalion is sinpIe,
enpiricaI evidence shovs lhal lhe re-
lurns are nol nornaIIy dislriluled.
Monle CarIo sinuIalion invoIves anaI-
ysis and randon sinuIalion of prina-
ry conponenls. The nelhodoIogy can
aIso handIe vide range of dislrilulions
and non-Iinear conlinalion of faclors.
Hovever, lhe nelhod is nosl conpu-
lalionaIIy inlensive. The choice of lhe
nelhod ly individuaI hrns depends
on lheir risk nanagenenl experlise,
avaiIaliIily of sufhcienl proprielary
and narkel dala and conposilion of
forex porlfoIio.
Irojeclion of cash ovs and use of
VaR neasures need lo le suppIenenled
ly appropriale sensilivily lesls lo
neasure lhe polenliaI Ioss lo lusiness
if lhe exchange rales prediclion lurns
lo le faIse. Slress scenarios shouId le
seIecled so as lo lake care of exlrene,
lul pIausilIe evenluaIilies.
Benchmarking and
formulation of policy
guidelines
In lhe Iighl of eslinaled risk and
exposures, an appropriale foreign
exchange risk nanagenenl poIicy
shouId le fornuIaled. The poIicy
shouId oulIay lhe responsiliIilies,
slralegies, oljeclives of hedging,
aulhorized hedging approaches
and inslrunenls, inlernaI conlroI
nechanisn and noniloring/ reporling
processes. The IoIicy shouId enconpass
risk appelile slalenenls. Slop Ioss
Iinils and nechanisns for reslricling
lhe Iosses in lhe evenl of prediclions
lurning vrong shouId forn parl of lhe
poIicy. A sel of conlroIs and nonilor
nechanisns shouId le deveIoped lo
ensure appropriale posilion laking.
This incIudes specihcalion of Iinils for
each hedging inslrunenl, noniloring
of MTM vaIualions of aII currency
posilions and selling of lenchnarks
for periodic noniloring of hedging
perfornance. The foreign exchange
risk nanagenenl poIicy shouId le
suljecled lo reviev on a reguIar lasis.
Risk mitigation
Conpanies can enpIoy one or nore
of a sIev of hedging looIs in Iine vilh lhe
oljeclives and risk loIerances Iaid oul
in lhe risk nanagenenl poIicy. Hedge
cosls, lenehls, risks and corporale
loIerances have a learing on lhe
feasiliIily of lhe looIs. The hrn shouId
hrsl consider naluraI hedges lefore
resorling lo use of hedge inslrunenls.
NaluraI hedging neans offselling
of lhe lolaI inovs againsl oulovs
(receivalIes & payalIes, inporl and
exporls) in a parlicuIar currency lased
on anounls and linings. NaluraI
hedging effecliveIy reduces forex risk
lul crealion of naluraI hedges is a line
consuning process and invoIves Iong
lern connilnenls.
Forward contracts, leing an
agreenenl lo purchase or seII specihed
anounl of foreign currency on a hxed
fulure dale al pre-specihed rale,
provides perfecl hedge for lransaclions
vilh cerlainly in lerns of anounl and
lining. Hovever, forvard conlracls
are nol narkelalIe and invoIve Ioss
of opporlunily gains in lhe evenl of
favoralIe exchange rale novenenl.
Iorvard conlracls are leing used
exlensiveIy lo hedge lrade lransaclions
vhere anounl and linings of cash
ovs are aInosl cerlain.
Currency options give lhe hoIder
lhe righl lul nol olIigalion lo luy (caII
oplion) or seII (pul oplion) specihc
quanlily of one currency in exchange
of anolher, vilhin or al lhe end of a
specihed period al a predelernined
41
Industry Insights
price. The naxinun Ioss on an oplion
is lhe preniun paid. Oplions are
lradalIe on exchanges and aIso enalIe
lhe user lo parlicipale in favoralIe
currency novenenls. Hovever,
exchange lraded currency oplions
are slandardized in lerns of Iol size.
Oplion is an ideaI hedge for conlingenl
cash ovs. Option contracts maybe
combined to form strategies that
reduce cost and achieve desired pay
nff prn!cs at maturIty.
Currency futures are slandardized
forex derivalive conlracls lraded on
a recognized slock exchange lo luy
or seII one currency againsl anolher
on a specihed fulure dale, al a price
specihed on lhe dale of conlracl.
Currency fulures lhough require
a snaII iniliaI oulIay, provide lhe
Ieverage of covering signihcanl
anounl of forex exposure. A currency
fulure conlracl can le cIosed lefore
sellIenenl dale ly saIe of an idenlicaI
fulures conlracl. Hovever, as lhe
nalurily and Iol size is slandard, il is
Iess laiIored lhan forvard conlracls.
In India, recognized exchanges are
pernilled lo offer currency fulures
in lhe pairs of USD-INR, LURO-INR,
CI-INR and }IY-INR in lhe Iol size
of 1OOO unils of foreign currency
(excepl for }IY vhere lhe Iol size is
1OO,OOO).
Currency svap invoIves exchange
of equaI iniliaI principaI anounls
of lvo differenl currencies al spol
rale lelveen lvo parlies. Inleresl
paynenls are nade al prehxed
inlervaIs in lhe respeclive svapped
currencies over lhe lern of conlracl.
Al nalurily, principaI anounls are re-
svapped al prehxed rales. Svaps are
used lo hedge exposures for Ionger
periods and aIso provide for hedging
of lransIalion risk.
Ioreign currency Ioans and foreign
currency denoninaled deposil
accounls provides aIlernalive
nelhods for forex risk nanagenenl,
vhich nay le used vhere nisnalch
exisls in lining of foreign currency
inovs and oulovs.
Iirns exposed lo differenl facels
of forex risk shouId praclice an
inlegraled approach lo hedge lhe
risks and consider using a louquel of
hedging inslrunenls, duIy laking inlo
accounl lhe nalure of risk exposures
and conducling cosl lenehl anaIyses.
Hedge oplinizalion nodeIs nay
le enpIoyed lo delernine lhe nosl
efhcienl hedging slralegy. Hedge
perfornance shouId le assessed
againsl hxed lenchnarks and
hedge slralegies shouId le revieved
accordingIy.
In lhe gIolaIized environnenl,
India shouId have a good narkel for
Iiquid foreign exchange derivalives
narkels lo reap lhe fruils of
IileraIizalion. Il is a veIcone sign lhal
lhe reguIalory aulhorilies in India is
focusing on enalIing effeclive forex
nanagenenl looIs connensurale
vilh lhe opporlunilies in a IileraIized
environnenl and inlroducing effeclive
checks and laIances lo nainlain a
heaIlhy foreign exchange narkel.
A gIolaI currency doing avay
vilh exchange rale risk vas once
dreanl ly rilish Lcononisl Dr }ohn
M Keynes and vas recenlIy echoed
ly US Treasury Secrelary. Il is lrue
lhal Luro and LMU lecane a reaIily.
Hovever lhe Luropean experinenl is
shaking. Hence, lhe inlegralion of lhe
counlries of lhe vider vorId operaling
on uneven econonic lerrain under a
Super Reserve Currency is loo pre-
nalure. Il is olvious lherefore lhal
nuIlipIe currencies are here lo slay
for lhe foreseealIe fulure and so is lhe
foreign exchange risk. The concern of
corporale, lanks and lraders shouId
le hov lesl lo slave off lhe forex risk
and slay aoal.
It is obvious that
multiple currencies
are here to stay for
the foreseeable
future and so is the
foreign exchange risk
Baby K P
Asst General Manager,
Federal Bank
Mr. aly K I is currenlIy vorking as Assl CeneraI Manager, in Treasury, Munlai
in IederaI ank. He has vide experience in differenl areas of lanking Iike lranches
, regionaI ofhces and in lhe corporale ofhce. A connerce graduale and a Charlered
IinanciaI AnaIysl fron ICIAI and vilh nany dipIonas in anking , Managenenl
and Iinance, he headed nany nelro and seni urlan lranches and has leen sleering
lhe liggesl region of lhe lank, lefore noving lo Treasury in year 2O12. A nenlor,
Ieader, good adninislralor, he is a cerlihed associale of Indian Inslilule of lankers. He
has leen in lhe Ieadership roIe in laking up nany successfuI projecls such as Croup
Housing projecls, LducalionaI Inslilulions for lhe veIfare of lhe ofhcers connunily of
lhe ank.
42
Industry Insights
for Corporates
I
oreign exchange risk nanage-
nenl lecane increasingIy in-
porlanl inlernalionaIIy afler
lhe aloIilion of hxed exchange rales
of rellon Woods in 1976. In a oal-
ing rale syslen currency novenenls
vere inuenced ly denand suppIy
faclors as veII as econonic and poIili-
caI faclors. This inpacled lhe prohl-
aliIily of conpanies exposed lo cur-
rency risk oul of lrade and dell.
In India, lhe graduaI IileraIizalion
of lhe Indian econony afler lhe 199Os
and ils inlegralion inlo lhe gIolaI
narkelpIace has resuIled in sulslanliaI
exposure lo foreign exchange risks
for Indian corporales aIso. The
disnanlIing of lrade larriers, access
lo gIolaI capilaI narkels/hedging
producls and lhe nove lo narkel-
delernined exchange rales has nade
il inperalive lo nanage lhe foreign
exchange risk in a judicious nanner.
Why manage foreign
exchange risk?
In recenl years, Indian corporales
have expanded lheir gIolaI foolprinl.
Nol onIy have lhey increased lheir
pursuil of gIolaI lrade opporlunilies
lul have laken on foreign currency
dell and acquired conpanies alroad.
One neasure of Indias gIolaI
inlegralion is lhe grovlh in lhe ralio of
lhe exlernaI lrade lo CDI fron 8 per
cenl in 1972 lo nearIy 4O per cenl nov
vhiIe non-lrade cross lorder ovs
have risen fron 14 percenl in 1972 lo
veII over 1OO per cenl of CDI nov.
As a resuIl lhe nonlhIy lurnover in
Mr. Mohan N. Shenoi, Iresidenl- Croup Treasury &
CIolaI Markels, Kolak Mahindra ank Liniled
In India, the gradual
liberalization of the
Indian economy after
the 1990s and its
integration into the
global marketplace has
resulted in substantial
exposure to foreign
exchange risks for
Indian corporates
43
Industry Insights
lhe Indian foreign exchange narkels
has grovn nore lhan 14 lines fron
USD 76 liIIion in 1996 lo over USD
1.O7 lriIIion in 2O12. This increased
inlegralion gives leller lusiness
opporlunilies in nornaI lines lul
during voIaliIe lines il poses innense
chaIIenges lo nanage risks.
In recenl lines vilh signihcanl
gIolaI econonic and geopoIilicaI
uncerlainly in lhe deveIoped vorId,
anid sIoving grovlh, Iong slanding
correIalions anong assel cIasses have
lroken dovn and currencies have
noved inlo never ranges. Markels
are nov driven nore ly Iiquidily
and evenls ralher lhan fundanenlaIs.
Sharp noves have lecone connon
as narkels sving lelveen risk on
and risk off scenarios. The lIack
svan has lecone lhe norn ralher
lhan a laiI evenl.
Thus, Iarger currency exposures,
lhe conconilanl voIaliIily in currency
narkels and lhe inpacl il has on cash
ovs as veII as reporled accounling
earnings have nade foreign exchange
risk nanagenenl inperalive for
Indian corporales.
Managing foreign exchange risk
provides lhe foIIoving lenehls lo
conpanies:
Mininize lhe negalive inpacl -
of exchange rale novenenls on
prohl nargins
Increase prediclaliIily of fulure -
cash ovs
LIininale lhe need lo accuraleIy -
forecasl exchange rales
IaciIilale conpelilive pricing -
Irolecl lhe conpanies conpeli- -
liveness in case lhe rupee appre-
ciales/depreciales
How is foreign exchange
risk managed?
Risk nanagenenl is lhe
perfornance of aclivilies designed lo
nininize lhe negalive inpacl (cosl) of
uncerlainly (risk) regarding possilIe
Iosses
Ioreign exchange risk nanagenenl
aIIovs lhe conpany lo focus on
naxinizing lhe operaling vaIue
of lheir hrn vhiIe nininizing lhe
hnanciaI disruplions caused ly
narkel uclualions.
The cornerslone for a rolusl
risk nanagenenl praclice legins
vilh having a veII-dehned oard
approved Risk Managenenl IoIicy
acconpanied ly proper execulion of
lhe sane as veII as conslanl revievs
and hne luning of lhe poIicy as
required. In nosl hrns, lhe execulion
of lhe poIicy is lhe responsiliIily of
lhe Chief IinanciaI Ofhcer or vhere
lhere is a separale Treasury, lhen il is
lhe roIe of lhe Treasurer.
The oard approved poIicy shouId
le consislenl vilh lhe slralegy,
connerciaI oljeclives and risk/
revard aspiralions of lhe conpany.
This is inporlanl since il vouId
provide operalionaI cIarily lo lhe risk
nanager. Ior exanpIe, a risk-averse
corporale vouId have lhe oljeclive
of nininizing lhe negalive inpacl of
foreign currency uclualions on lhe
rupee denoninaled cash ovs. So if
lhe guiding principIe is conservalisn
lhen il vouId diclale lhe choice of
hedging inslrunenls, hedge cover
ralios, lenchnarks and lhe linefrane
or dynanisn vilh vhich lhe hedges
are nanaged. On lhe olher hand, if lhe
oljeclive is lo generale non-operaling
earnings ly virlue of uclualions in
lhe narkels lhen lhe choices vouId
le differenl.
The risk nanagenenl poIicy shouId
le prinariIy driven ly lhe lusiness
lhe conpany is in.
Il shouId start by isolating and
enumerating the currency exposures
nf thc rm. Currcncy cxpnsurcs arise
fron any of lhe foIIoving:
A. Transaction Risk: This arises oul
of cash ovs in foreign currency lhal
needs lo le converled lo doneslic
currency. These couId le inporls,
exporls, receipls or paynenls,
inleresl ovs, dividend ovs, Ioan
repaynenls.
B. Translation Risk: This reIales lo
lhe risk arising oul of lransIalion of
foreign currency assels or IialiIilies in
lhe laIance sheel.
C. Contingent Risk: As lhe nane
suggesls, lhese are conlingenl foreign
currency exposures lhal arise in
speciaI silualions.
D. Economic Risk: This refers lo lhe
currency risk lhal is enledded in lhe
lusiness ilseIf and couId arise oul of
faclors Iike inpul or oulpul cosls leing
Iinked lo lhe exchange rale, lhreals
fron inporls, correIalion lelveen
connodily prices and exchange rales
elc. This is of parlicuIar signihcance
as lhe inpacl of lhis, vhiIe nol so
olvious, can le very signihcanl in
fornuIaling lhe risk nanagenenl
poIicies and lhe hedging slralegies.
E. Policy Risk: These are risks lhal
cryslaIIize lecause of sudden change
in governnenl poIicies. Hovever il
is very difhcuIl lo forecasl and hedge
lhese exposures.
Once lhe risks are enuneraled, il
shouId lhen eslalIish lhe procedure
and paranelers for inpIenenlalion
of lhe progran on an ongoing lasis
vhich incIudes lhe procedure lo reporl
exposures, assign risk nanagenenl
responsiliIily, idenlify appropriale
hedging looIs and afhx appropriale
lenchnarks.
One of lhe key issues is lhe hedging
decision for each exposure, ils line-
frane and lhe lenchnarks lo le sel.
The decision vhelher lo hedge or nol
(a parlicuIar exposure) and lhe exlenl
lo vhich hedging is used is delernined
ly lhe size of lhe exposures in reIalion
lo lhe hrns size and ils naleriaI
inpacl on lhe reporled earnings.
Sulsequenl adjuslnenls lo lhe hedges
are done keeping in nind, lhe narkel
condilions, nanagenenl poIicy and
The risk management
policy should be
primarily driven
by the business the
company is in
44
Industry Insights
concurrenl RI reguIalions. Ior
conservalive conpanies, lhe hedging
lenchnark for lrade exposures couId
le lhe oulrighl forvard rale al lhe
slarl of lhe exposure (1OO cover
rale). A risk-seeking hrn couId sel
an aggressive lenchnark of lhe lesl
oulrighl forvard cover rale al any
line during lhe Iife of lhe exposure.
Il shouId aIso nandale lhe nininun
and naxinun hedge ralio for each
lype of exposure, draving fron lhe
hedging principIes Iaid dovn ly
nanagenenl.
AIso, il shouId creale appropriale
conlroIs ly assigning aulhorily,
deaIing Iinils, lanking reIalionships
and prevenl deaIing ly unaulhorized
individuaIs and in prohililed
lransaclions/ producls. Ior exanpIe,
if lhe nanagenenl is risk-averse lhen
usage of conpIex derivalive producls
as veII as lhird currency hedging can
le prohililed.
IinaIIy il shouId Iay dovn lhe
syslen for exposure noniloring,
neasurenenl, evaIualion, reporling
and eslalIish a reasonalIe ludgel for
lhe hedging progran. This can incIude
lhe cosls of using hedging inslrunenls
such as lhe preniuns paid for oplions,
cosls of infornalion syslens, soflvare
and olher adninislralion cosls.
How can foreign exchange
risk be managed?
Ioreign exchange risk can le
nanaged prinariIy ly lvo nelhods.
Hedging is lhe prinary nelhod ly
vhich foreign exchange exposure of
a conpany is nanaged vhiIe non-
hedging lechniques can aIso le used.
Non-hedging lechniques incIude 1.
sellIenenl of lransaclions lhrough
advance paynenl lo reduce line-
frane of exposure and invoicing in
lhe hone currency lo foreign coun-
lerparlies lo eIininale lhe risk.
Hedging lechniques are aIso of 2.
lvo lypes. They incIude inlernaI
hedging such as nalching/
nelling of receivalIes/ payalIes
and raising dell in lhe currency
of receivalIes. LxlernaI hedging
invoIves lhe use of hnanciaI
inslrunenls such as (a) Iorvard
Conlracls () Currency Oplions
(c) Lxchange lraded currency
fulures (d) Currency Svaps
The choice of exlernaI hedging
inslrunenls is diclaled ly lhe risk
vhich is leing soughl lo le hedged.
Iorvard conlracls are usuaIIy used
lo hedge shorl-lern lransaclion
risks arising oul of cash ovs vhiIe
currency svaps are used lo hedge
Ionger-lern lransIalion risk oul of
say foreign currency dell. Currency
oplions are lesl suiled lo hedge
conlingenl risks oul of say lidding
conlracls. Hovever of Iale in lhe
Indian narkel, lhere has leen Iol
of inleresl in hedging lransaclion
risks lhrough currency oplions. This
inleresl is driven ly lhe high voIaliIily
in exchange rales lecause of vhich
corporales are reIuclanl lo Iock on
lo lhe exchange rales using forvard
conlracls vhiIe al lhe sane line vanl
lo prolecl any dovnside arising oul of
unhedged exposures.
Recent Lessons
The exlrene voIaliIily oul of lhe
geopoIilicaI evenls in lhe gIolaI
currency narkels has proved lhe
necessily lo have in pIace a prudenl
and eIalorale foreign exchange risk
nanagenenl progranne. The recenl
evenls posl-2OO8 have nany Iessons
in foreign exchange risk nanagenenl
for corporales.
IirslIy, corporales have seen lhal
lhe inpacl of lhe risk of keeping
Iarge exposures un-hedged can le
signihcanl especiaIIy vhen lhere
are Iarge novenenls in exchange
rales hence lhere has leen focus on
nanagenenl of such Iarge exposures.
SecondIy, lhe risks in shifling
focus fron core lusinesses lo
aclive nanagenenl of exposures
have sonelines Ied lo undesiralIe
oulcones.
ThirdIy, lhe choice of hedging
inslrunenls such as lhird currency
hedging, conpIex derivalive producls
having asynnelricaI pay-offs have
lheir ovn specihc risks and again nay
nol le effeclive vhen lhere are sharp
noves and correIalions lreak dovn.
IourlhIy, risks of hedging lased
on pasl perfornance vhen lhe enlire
underIying lusiness scenario is under
lhreal aIso surfaced in nany cases.
IiflhIy, lhe alsence of scenario
pIanning in lhe case of adverse
novenenl Ied lo inaclion in nany
cases and causing Iosses.
Hedge accounting:
WhiIe il is inporlanl lo have veII
dehned hedging slralegies, il is
45
Industry Insights
equaIIy inporlanl lo ensure lhal lhese
hedging slralegies have lhe correcl
inpacl on lhe slalenenl of accounls.
In nany cases, lhe hedges vhiIe leing
econonicaIIy sound, have Ied lo Iosses
fron an accounling perspeclive.
Many lines lhis has Ied lo corporales
fornuIaling hedging slralegies lased
on accounling consideralions ralher
lhan econonic consideralions.
In order lo address lhis issue, a
fev corporales have adopled hedge
accounling slandards. This ensures
lhal lhe accounling lrealnenl of
hedges is aIigned vilh lhe econonic
ralionaIe of lhe sane and lhus lhere
are no dislorlions in lhe slalenenl
of accounls arising oul of hedging
lransaclions. Hovever, il nusl le
renenlered lhal hedge accounling
pIaces Iol of onerous requirenenls on
lhe corporales Iike docunenlalion,
syslens lo record and nonilor lhe
sane, as veII as various discIosures
in lhe slalenenl of accounls.
RBI regulations:
The RI reguIalions on foreign
exchange, vhich are one of lhe key
delerninanls of corporales hedging
slralegies have aIso leen conslanlIy
evoIving over lhe years. The
fundanenlaI principIe guiding lhe
RI reguIalions is lhal corporales can
enler inlo foreign exchange conlracls
onIy for lhe purpose of hedging.
The reguIalions on vhal are lhe
exposures lhal are pernissilIe for
hedging have aIso leen changing
over lhe years and lhe Iisl has leen
groving conslanlIy. WhiIe iniliaIIy
onIy conlracled exposures couId
le hedges, over lhe years RI has
pernilled hedging lased on pasl
perfornance, hedging of conlingenl
exposures as veII as hedging of
cerlain kinds of econonic exposures.
The inslrunenls aIIoved for
corporales have aIso leen changing
over lhe years. Hovever vhiIe RI had
earIier given corporales consideralIe
Ieevay in lhe choice of hedging
inslrunenls (incIuding exolics) for
non INR conlracls, foIIoving lhe
issues in lhe narkel posl 2OO8, onIy
pIain vaniIIa hedging inslrunenls
have leen aIIoved.
In addilion, RI has aIso increased
lhe docunenlary requirenenls fron
corporales lo ensure conpIiance
vilh lhe guideIines. This is in lhe
forn of docunenls evidencing
proof of underIying exposures, pasl
perfornance in lerns of exporls
and inporls, quarlerIy cerlihcales
fron slalulory audilors ensuring
conpIiance vilh aII lhe guideIines
as veII as annuaI cerlihcales fron
lhe oard of direclors. This has
pIaced addilionaI responsiliIilies
on corporales in lerns of selling
up lhe infraslruclures lo conpIy
vilh aII lhe requirenenls and lhe
acconpanying cosls. Hovever, lhese
nay le necessary in lhe shorl run,
liII lhe narkels allain nalurily and
lhe RI in lurn gains conforl in lhe
syslen. In lhe Iong run, reIaxalion
of lhe alove neasures is Iinked lo
lhe overaII poIicy of lhe counlry on
capilaI converliliIily.
In concIusion, lhe resurgence
of foreign lrade - conlined vilh
voIaliIily in lhe gIolaI hnanciaI
narkels- heighlens lhe inporlance
of having a proper foreign exchange
risk nanagenenl in pIace. A veII
docunenled poIicy aIIovs lhe hrns
nanagenenl lo focus on nev lusiness
opporlunilies vilhoul any concern
aloul hov ils risk exposures vouId
inhilil ils expansion pIans.
The tleus exressed ln the artlc|e are ersona| and do not reect the tleus of Kotak Mahlndra Bank Ltd.
Mohan N. Shenoi
President- Group Treasury
& Global Markets
Kotak Mahindra Bank
Limited
Mohan Shenoi Heads inlegraled lreasury (incIudes Iorex, Iixed Incone, Money Markels,
Derivalives and uIIion), Irinary DeaIership, Dell CapilaI Markels and lhe aIance Sheel
Managenenl Unil.
He is aIso a Direclor al Kolak Mahindra Irine Lld. and Direclor al Kolak Iorex rokerage
Liniled.
Shenoi slarled his lanking career al Corporalion ank in 1978. He vas responsilIe
for shifling lhe Corporalion ank Treasury fron MangaIore, H.O. lo Munlai in 199O.
Corporalion ank Treasury lhereafler lecane one of lhe veII-knovn ank Treasuries.
He joined ICICI ank in 1994 - lhe 5lh enpIoyee lo join ICICI ank and nenler of lhe
originaI lean vhich sel up lhe ank.
He noved fron Treasury lo IIanning in ICICI ank in 1996. Was lhe Head of RelaiI in
2OOO-O1.
Shenoi is a acheIor in usiness Managenenl (M), Cerlihcaled Associale of Indian
Inslilule of ankers (CAII),
Iosl Craduale DipIona in ank Managenenl (ICDM)
46
Industry Insights
A perspective on the trends in the foreign
exchange market and identifying and managing
foreign exchange risk
Introduction
The foreign exchange narkel has
grovn ly Ieaps and lounds since
lhe coIIapse of lhe rellon Woods
syslen in 1971, vhich aIso narked lhe
leginning of lhe oaling exchange rale
regines in nany counlries. Wilh daiIy
lurnover in excess of $4 lriIIion, il has
lecone lhe Iargesl narkel in lhe vorId.
Hovever, over lhe Iasl fev years, lhe
foreign exchange narkel has seen a
spiII-over fron sIoving inlernalionaI
lrade and inveslnenl ovs, oving
lo lhe heighlened uncerlainly in
vake of nuled recovery fron lhe
hnanciaI crisis. As lhe Iiquidily across
narkels dried up, lhe hnanciaI crisis
chaIIenged lhe nicro-slruclure of
foreign exchange narkels across nany
counlries vilh increased voIaliIily.
Though condilions have eased since,
risk nanagers are sliII grappIing vilh
heighlened lusiness uncerlainly,
assel narkel voIaliIily and slringenl
reguIalory norns. In chaIIenging
lines Iike lhese, lhe praclice of foreign
exchange risk nanagenenl needs lo
conslanlIy evoIve, adapl and engage
aII lusiness slakehoIders lo ensure
a pronpl, snoolh and inleIIigenl
decision naking process.
In lhe seclions ahead, I viII
ain lo share ny lhoughls on lhe
deveIopnenls in lhe foreign exchange
narkel and provide an overviev on
foreign exchange risk nanagenenl,
vilh a reference lo lhe approach
al L&T.
Mr. Ramaswamy Govindan, Vice Iresidenl (Corporale Iinance&
Risk Managenenl), Larsen & Toulro Liniled.
As the liquidity across
markets dried up,
the pnancla| crlsls
challenged the micro-
structure of foreign
exchange markets
across many countries
with increased
volatility
47
Industry Insights
Global FX Markets Deep,
liquid but volatile
The decade of lhe 199Os vas
vilness lo a visilIe poIicy shifl in
nany energing narkels lovards
reaIigning lheir hnanciaI narkels
for nev producls and inslrunenls,
pronoling inslilulionaI and narkel
infraslruclure and a rejig of lhe
reguIalory franevork consislenl vilh
lhe IileraIised operaling environnenl.
The changes resuIled in a rapid
expansion of foreign exchange narkel
in lerns of parlicipanls, lransaclion
voIunes, decIine in lransaclion cosls
and nore efhcienl nechanisns of risk
lransfer.
In lhis lackdrop, lhe voIunes in lhe IX
narkel have conlinued lo rise rapidIy.
Draving on lhe 2O1O IS TrienniaI
Survey of Ioreign Lxchange and
Derivalives Markels, lhe gIolaI foreign
exchange lurnover grev ly 2O percenl
over lhree years. This rale of grovlh vas
sIover lhan lhe rapid 72 percenl grovlh
rale seen in lhe 2OO7 survey.
Turnover conlinued lo le doninaled
ly lhe four najor currencies. The US
doIIar nade up one Ieg in 85 per cenl
of lransaclions, lhe euro vas used in
cIose lo 4O per cenl of lransaclions and
lhe }apanese yen vas used in around
2O per cenl of lransaclions. The rilish
pound vas exchanged in around 13
per cenl of deaIs, vilh lhe share of
lurnover conducled in lhe rilish
pound conlinued lo faII.
The pallern of grovlh across
inslrunenls differed fron lhe previous
lhree-year period. Spol lurnover
increased ly 48 per cenl over lhe lhree
years lo ApriI 2O1O, foIIoving a 59 per
cenl increase over lhe previous lhree
years. In conlrasl, lurnover in foreign
exchange svaps increased ly onIy
3 per cenl, conpared vilh an 8O per
cenl rise lelveen 2OO4 and 2OO7. As a
resuIl, lhe share of spol lransaclions in
lolaI lurnover had increased lo 37 per
cenl fron 3O per cenl, vhiIe lhe share
of lurnover accounled for ly foreign
exchange svaps feII lo 44 per cenl
fron 52 per cenl. Turnover in lhe olher
inslrunenls - forvards, cross-currency
svaps, and OTC oplions - conlinued
lo le nuch Iover on average lhan for
spol and foreign exchange svaps.
The survey cIearIy highIighled lhal
lhe grovlh in lurnover vas driven
ly denand fron 'olher hnanciaI
inslilulions. The gIolaI hnanciaI crisis
had laken ils loII on lhe cross lorder
lrade and inveslnenl ovs. As a resuIl,
for lhe hrsl line in lhe hislory of lhe
survey, lurnover lelveen deaIers and
olher hnanciaI inslilulions vas higher
lhan lhe lurnover vilh lhe inlerdeaIer
narkel.
The survey aIso shovs lhe increasing
aclivily in lhe spol narkel lhrough
eIeclronic pIalforns. The grovlh in
eIeclronic lrading has increasing lhe
scope for high-frequency and aIgorilhn
lased lrading in lhe foreign exchange
narkel. AIlhough, lhese 'lechnoIogy
aided slralegies lring enhanced
Iiquidily and Iover lransaclion cosls
lo lhe lalIe, lhey are aIso a source of
'unvanled voIaliIily in lhe narkel
space.
The FX market in India
The origin of lhe foreign exchange
narkel in India can le lraced lo 1978
vhen lanks vere pernilled lo lake
inlra-day lrades in foreign exchange.
Hovever, il vas onIy in lhe 199Os,
lhal India vilnessed a Iandscape
change in lhe foreign exchange narkel
aIong vilh shifls in currency regine.
A furlher inpelus lo lhe foreign
exchange narkel vas provided ly
lhe selling up of lhe experl group on
Ioreign exchange lhal sulnilled ils
reporl in }une 1995, providing various
neasures for deepening and videning
lhe IX narkel in India. Since lhen,
heIped ly a rapidIy expanding gIolaI
narkel, higher risk appelile of lanks
and corporale, lhe foreign exchange &
ils derivalive narkel in India has seen
consislenlIy increasing voIunes and
inproved Iiquidily. Al a daiIy average
lurnover of $37 liIIion, lhe share of
India in lhe gIolaI IX lurnover has
renained conslanl al O.9 percenl fron
2OO7 lo 2O1O IS Survey.
The derivalives prinariIy used in
lhe Indian conlexl incIude forvards,
oplions and currency svaps. AvaiIalIe
dala indicales lhal nosl videIy used
inslrunenls are lhe forvards and
foreign currency svaps. OTC currency
oplions voIunes have nol gained
lraclion given lhe Iov Iiquidily and lhe
reguIalory reslriclions in lhis space.
Currency fulures are anolher producl
lhal vas Iaunched in 2OO8 and has in
lhe Iasl lvo years seen a slrong pick up
in voIunes.
The IX narkel in India is slriclIy
reguIaled. Though efforls have leen
nade ly lhe cenlraI lank lo ease lhe
norns, gIolaI hnanciaI condilions have
al various poinls sIoved dovn lhe
reforns process. One such fealure is
lhe 'roIe of an underIying lransaclion
in looking of a forvard conlracl.
48
Industry Insights
This fealure is unique lo lhe Indian
derivalives narkel. In lhe lackdrop
of lhe corporale leing given increased
freedon lo lap lhe foreign exchange
narkels, lhe cenlraI lank has insisled
in lhe requirenenl of an underIying
in order lo curl excess voIaliIily and
specuIalion in lhe nascenl narkel.
In lhe Iasl 2 years, lhe cenlraI lank,
on various occasions, has increased
lhe oversighl on lhe lransaclions in
lhe foreign exchange narkel. Under
lhis slricler operaling environnenl,
an increasing nunler of corporales,
especiaIIy, lhe nediun scaIe
enlerprises have found il difhcuIl
lo keep up vilh lhe reguIalory
requirenenls. The Decenler 2O11
circuIar lhal lans lhe relooking of
canceIIed forvard conlracls under lhe
sane underIying exposure has driven
nany corporales avay fron lhe OTC
narkel and has inpacled lhe spol
narkel Iiquidily adverseIy.
A direcl lenehciary of lhis has leen
lhe currency fulures narkel. VoIunes
have zooned in lhe NSL currency
fulures segnenl, vilh nore and nore
corporales pIayers nov aclive on lhe
exchanges. Hovever, lhe exchange
provides onIy a slandardised producl
and lhe Iiquidily renains poor leyond
lhe near-nonlh conlracl.
To sunnarise, aII lhe recenl
lrends in lhe Indian IX narkel have
nade effeclive and dynanic risk
nanagenenl a chaIIenge. This reduced
nanoeuvraliIily, aIong vilh exogenous
and endogenous nacroecononic
shocks are lig chaIIenges for foreign
exchange risk nanagenenl for an
Indian Corporale.
Management L&T
Perspective
In Iighl of lhe lighlIy coupIed foreign
exchange narkels and conpIex and
uncerlain lusiness environnenl,
foreign exchange risk nanagenenl
has evoIved fron leing a slandaIone
funclion lo a roIe vhich is conpIeleIy
inlegraled vilh lusiness and has lo
le unifornIy inpIenenled across lhe
organizalion.
Risk nanagenenl franevork and
lhe conlours of lhe approach have
undergone a radicaI shifl in order
lo ride lhe unprecedenled voIaliIe
lines. Mosl crilicaI here is lhe lop
nanagenenl recognilion of lhe
crilicaIily of foreign exchange risks -
al slralegic, laclicaI and operalionaI
IeveIs.
The L&T Croup handIes hnanciaI
risk nanagenenl lhrough a cenlraIized
Treasury funclion -and olher lusiness
risks lhrough a cenlraI reviev-
decenlraIized nanagenenl approach.
Risk nanagenenl is cIearIy vieved as
a parl of lhe conpany's overaII slralegy
and a vay lo conpele effecliveIy
on lhe lusiness fronl. Il has lecone
inperalive lo appIy anaIylics lo creale
a forvard Iooking risk franevork lhal
keeps lhe conpany al lhe lop of lhe
Ieader loard.
To inpIenenl lhe sane, lhe risk
nanagenenl franevork needs fev
pre-requisiles -
Managenenl connilnenl -
& a lroad oard approved
franevork, incIuding Risk
nanagenenl connillees
aIso conprising independenl
direclors
CIarily in roIes and responsiliIi- -
lies - Risk ovner/Aggregalor /
AnaIyzer /Decision Maker /Lx-
eculion vhich hls lesl fron lhe
poinl of viev of lhe slruclure of
lhe organizalion, risk prohIe,
geographicaI spread, reguIa-
lion, accounling and so on
A lop-dovn approach lo selling -
loIeralIe risk paranelers vilhin
vhich sulsequenl decisions
need lo le hlled
A rolusl process /syslen lo -
aggregale risks and anaIyze
lhen
A slrong Treasury/Corporale -
Iinance funclion nanned ly
professionaIs vilh hnanciaI
narkel and risk nanagenenl
experlise, supporled ly a su-
perior exlernaI inleIIigence nel-
vork of hnanciaI inslilulions
Al L&T, lhe franevork is spIiced
across lhe organizalion lhrough
lusiness specihc risk nanagenenl
connillees vhich vork in landen
vilh lreasury connillee al corporale
IeveI. This ensures process of risk
nanagenenl is inpIenenled across
organizalion. CenlraIized guideIines
are fornuIaled lo ensure unifornily.
Risk management process
involves following elements:-
RIsk IdcntIcatInn:
Differenl lypes of lusinesses face
differenl lypes of forex exposure
reIaled risks. TypicaIIy for a projecl
lype of lusiness invoIving nuIlipIe
currencies, forex risks viII arise
fron Iong lenors of projecl, paynenl
niIeslones invoIved and uncerlainly
Under this
stricter operating
environment, an
increasing number of
corporates, especially,
the medium scale
enterprises have found
It dIfcu!t tn kccp up
with the regulatory
requirements.
49
Industry Insights
invoIved in lining of cashovs.
On lhe olher hand, producl
lusiness viII gel affecled due lo
nacroecononic faclors vhich in lurn
viII aIler producl denand cycIe. In
currenl environnenl vhere sourcing
is gIolaI and producls nanufaclured
are exporled lo aII corners of vorId,
such changes inevilalIy expose an
organizalion lo forex risks vhich viII
inpacl prohlaliIily.
Il, lhus, lecones inperalive lo
idenlify lhese risks lased on lusiness
needs and inlricacies so lhal correclive
aclions can le laken proacliveIy. TooIs
Iike risk regisler can le effecliveIy used
lo luiId a slrong reposilory of risks
perlaining lo specihc lusinesses. Il aIso
acls as a reposilory of unforeseen forex
risks energing fron unprecedenled
noves in currency narkels (a Ia lIack
svan evenls) and assisls in preparing
for suilalIe conlingency neasures.
Risk Evaluation:
Risk evaIualion as lhe nane suggesls
invoIves eslinalion of IikeIy inpacl in
case lhe risks envisaged naleriaIize
and hov lhey viII affecl prohlaliIily of
a lusiness. Wilh evoIving conpIexily
in currency narkels and high IeveI of
correIalion lelveen currencies, ve have
lo evoIve our nelhods used lo evaIuale
forex risk and ils inpacl as veII.
A quanlilalive approach is lhus nore
suiled in lhis silualion. The oljeclive
is lo eslinale inpacl as accuraleIy as
possilIe covering as nany scenarios
and aIlernalives and ensure a IargeIy
shock proof porlfoIio of risks. Hence
anaIysis of forex risk inpacl is done
using sinuIalion lased nodeIing lo
incorporale currency lrends, currency
correIalions, cross assel correIalions lo
arrive al IikeIy inpacl. CrilicaI poinl lo
nole here is lhal inpul and fornuIalion
of appropriale nodeIs is essenliaI lo
successfuI inpIenenlalion of lhese
looIs.
Risk Mitigation:
The nain oljeclive al lhis slage is lo
evaIuale differenl hedging aIlernalives
in lerns of inslrunenl seIeclion vhiIe
ensuring choice of slralegy is consislenl
vilh poIicy oljeclives.
LvaIualing use of ReaI oplions is
aIso a very effeclive slralegy.
Risk monitoring:
As il has leen highIighled in lhe
preIude lo risk nanagenenl, currency
narkels nov operale 24 hours a day
and aInosl 365 days a year. Hence
aclions laken lo niligale forex risk in
lhe previous sleps can go off lhe largel
due lo uclualions in currency narkels.
Risk noniloring is essenliaI lo lrack
lhe changes and lake correclive aclions
lo approprialeIy adjusl niligalion
neasures.
Civen lhe conpIexily of lusiness
operalions, lop nanagenenl needs
lo le alreasl of aII such aclion in reaI
line lasis lo lake svifl aclions. TooIs
Iike risk dashloard is an effeclive vay
lo caplure essence of forex risk inpacl.
Il nol onIy gives us an idea of inpacl as
on dale lul can aIso provide vaIualIe
insighls inlo fulure scenarios. This
slruclured process forns lhe lacklone
of forex risk nanagenenl process. I
leIieve lhal ve shouId le alIe lo neel
chaIIenges lhrovn al us ly forex risk
head on vilh lhe heIp of an appropriale
nix of skiII sel, advanced looIs and
slandardized processes inpIenenled
lhroughoul lhe organizalion.
Ramaswamy Govindan
VIcc PrcsIdcnt (Cnrpnratc FInancc&
RIsk Managcmcnt) In Larscn &
Toubro Limited.
Mr. Ranasvany Covindan is Vice Iresidenl (Corporale Iinance& Risk
Managenenl) in Larsen & Toulro Liniled. He heads lhe Treasury and
Iinance funclions incIuding regionaI hnance / lreasury cenlers oulside
India. He nanages lhe hnance / lreasury porlfoIio of nore lhan 1OO
group conpanies al poIicy IeveI. Has leen a parl of nany inlernalionaI/
doneslic lenchnark lransaclions in various spheres for L&T Croup
(CDR, QII, ICC).
Mr. Covindan aIsooversees lhe enlerprise risk nanagenenl funclions for
lhe group.
Covindan has done Sc (Slalislics) fron LoyoIa CoIIege Madras and done
his Iosl Craduale DipIona in Managenenl fron IRMA, Anand.
References
Indian Derivatives Market a regulatory and Contextual Perspective - RBI Speeches
BIS Triennial Survey 2007 & 2010 ww.bis.org
Report on Currency & Finance RBI Publications
50
Industry Insights
Smt. Usha Ananthasubramanian,
Lxeculive Direclor, Iunjal NalionaI ank
The Backdrop
(G!nba!Isation and
IntcrnatInna! BusIncss)
CIolaIizalion, connonIy under-
slood as acceIeralion and exlension
of inlerdependence of econonic and
lusiness aclivilies across nalionaI
loundaries, has lecone a luzzvord
of nodern lines. Ils an inevilalIe phe-
nonenon in hunan hislory vhich has
leen lringing lhe vorId cIoser since
lhe line of earIy lrade and expIoralion
lhrough lhe exchange of goods, prod-
ucls, infornalion, jols, knovIedge and
cuIlure. Whal is unique is lhe pace and
scope of gIolaI inlegralion resuIling
fron unnalched advancenenls and
reduclion in lhe cosl of lechnoIogy,
connunicalions, science, lransporl
and induslry. Markels have lecone
nore inlervoven and lhe produclion
process has leen nade nore efhcienl
ly lhe oplion lo creale 'vorId prod-
ucls. AIso, lhe aliIily lo ship inforna-
lion and producls easiIy and econoni-
caIIy fron one counlry lo lhe nexl and
lo Iocale lhe nanufacluring process
vhere Ialour and vork processes are
Iess expensive, has changed lhe pal-
lern of produclion and consunplion
across lhe vorId.
CIolaIisalion has yieIded
nagnaninous scope for inlernalionaI
lusinesses. InlernalionaI lusiness
refers lo lhe lusiness aclivilies
lhal invoIve lransfer of resources,
goods, services, knovIedge, skiIIs, or
infornalion across nalionaI loundaries
and incIudes inlernalionaI lrade and
Globalisation
has yielded
magnanimous scope
for international
businesses
51
Industry Insights
inveslnenl. Resources nay le hunan,
capilaI or rav naleriaI. Coods nay le
seni-hnished or hnished assenlIies and
producls. Services incIude accounling,
IegaI counseI, lanking, insurance,
nanagenenl consuIling, lrade service,
educalion, heaIlh care, and lourisn,
anong olhers. KnovIedge and skiIIs
incIude lechnoIogy and innovalion,
organizalionaI and nanageriaI skiIIs,
and inleIIecluaI properly righls such
as copyrighls, lradenarks, and lrand
nanes. Infornalion ovs incIude
dalalases and infornalion nelvorks,
anong olhers. The parlies invoIved
nay le individuaIs (e.g., lourisls and
individuaI inveslors luying foreign
slocks or londs), conpanies (privale
or pulIic), conpany cIuslers (e.g.,
aIIiances), governnenl lodies (e.g.,
cenlraI lanks), and inlernalionaI
inslilulions (e.g., lhe WorId ank,
lhe IMI). Of lhese, conpanies are
lhe doninanl pIayers. The hrn is lhe
prinary econonic agenl faciIilaling
and gaining fron gIolaIizalion.
Aclivilies and exchanges invoIving
lhe crossing of nalionaI loundaries
are caIIed inlernalionaI lransaclions.
InlernalionaI lransaclions are
nanifesled nainIy in inlernalionaI
lrade and inveslnenl. InlernalionaI
lrade occurs vhen a conpany exporls
goods or services lo luyers (inporlers)
in anolher counlry. InlernalionaI
inveslnenl occurs vhen lhe conpany
invesls resources in lusiness aclivilies
oulside ils hone counlry.
Indian Perspective To
Economic Liberalisation
And International
Businesses
Ior decades afler independence in
1947, India enlarked on a progran
of aularky (nalionaI econonic seIf-
sufhciency). India slarled econonic
IileraIizalion in 1991 afler pursuing
an inporl sulslilulion slralegy for
nearIy forly years. Inporl Sulslilulion
slralegy allenpled lo acceIerale lhe
deveIopnenl ly Iiniling inporls
of nanufaclured goods, in order lo
fosler nanufacluring seclor serving
lhe doneslic narkel. The Iogic lehind
vas lhe Infanl Induslry Argunenl
saying nev nanufacluring induslries
in deveIoping counlries cannol
iniliaIIy conpele vilh veII-eslalIished
nanufacluring in deveIoped
counlries. To aIIov nanufacluring
lo gel a loehoId, lhen, governnenls
shouId lenporariIy supporl nev
induslries unliI lhey have grovn
slrong enough lo neel inlernalionaI
conpelilion. Thus, according lo lhis
argunenl, lariffs or inporl quolas
vere used as lenporary neasures
lo gel induslriaIizalion slarled. Il is a
hisloricaI facl lhal sone of lhe vorIds
Iargesl narkel econonies legan lheir
induslriaIizalion lehind lrade larriers
onIy. The Uniled Slales had high lariff
rales on nanufacluring in lhe 19lh
cenlury, vhiIe }apan had exlensive
inporl conlroIs unliI lhe 197Os.
y 1991, hovever, a sIuggish Indian
econony conlined vilh lhe forces of
econonic IileraIisalion Ied lo a nore
open econony. The neo-IileraI poIi-
cies incIuded opening for inlernalion-
aI lrade and inveslnenl, dereguIalion,
inilialion of privalizalion, lax reforns,
inalion-conlroIIing neasures, Sin-
pIifying procedures of lusiness, i.e.
inveslnenl, lrade elc. such as doing
avay vilh lhe Iicense, pernil and Less
inlervenlionisl and nore co-operalive
roIe of lhe Covernnenl in econonic
affairs, i.e. faciIilaling lusiness ralher
lhan conlroIIing il. There vas sinuIla-
neousIy a graduaI rise in InlernalionaI
lrade, inveslnenl and overaII econon-
ic grovlh.
As per WTO, in 2O11 lhe vorId as a
vhoIe produced goods and services
vorlh aloul $69.9 lriIIion, al currenl
prices. Of lhis lolaI, approx. 3O Iercenl
vas soId across nalionaI lorders.
WorId lrade in goods and services
exceeded $2O.O3 lriIIion. In lhe
sane year India vas lhe 19lh Iargesl
nerchandise exporler and 12lh Iargesl
inporler in lhe vorId vilh shares of
1.7 per cenl and 2.5 per cenl in vorId
exporls and inporls respecliveIy.
Indias nerchandise exporls increased
ly 21.3 per cenl lo reach US $ 3O4.6
liIIion vhiIe inporls increased ly 32.3
per cenl lo US $ 489.2 liIIion in 2O11-
12. In connerciaI services, India vas
lhe 8lh Iargesl exporler and 7lh Iargesl
inporler in lhe vorId vilh shares of
3.3 per cenl and 3.1 per cenl in vorId
Tnta! Tradc In 5crvIccs (U5$ bn) Tnta! Tradc In McrchandIsc (U5$ bn)
52
Industry Insights
exporls and inporls respecliveIy.
Indias service exporl increased lo US
$ 14O.9 liIIion and inporls increased lo
US $ 76.9 liIIion in 2O11-12. In IY2O12,
lhe lolaI lrade CDI ralio of India
increased lo 42.9.
Risk nay le lroadIy dehned as
prolaliIily of occurrence of an evenl
lhal causes a Ioss or reduclion in
expecled gains in lhe fulure. Lvery
lusiness has Inherenl risks vhich nay
differ depending on lhe underIying risk
faclors. AII inlernalionaI lusinesses
(Trade, Inveslnenls, lorrovings elc.)
Iead lo inlernalionaI lransaclions,
vhich in lurn yieId IORLX posilions/
exposures. These IORLX posilions
exhilil sone unique sel of risks vhich
are enIisled hereunder:
Lxchange Rale Risk 1.
Inleresl Rale Risk 2.
Counlry/Sovereign Risk 3.
ConpIiance Risk 4.
SellIenenl Risk 5.
1. Exchange Rate Risk: The price of
one currency in lerns of anolher is
caIIed as exchange rale. Risk of Iosses
due lo adverse uclualion of exchange
rales is caIIed exchange rale risk.
a) Lxporler suffers vhen doneslic
currency appreciales.
l) Inporler suffers vhen doneslic
currency depreciales.
c) LialiIilies viz. LCs, ICL/ICTL,
uyers Credil, ICIC increase in
vaIue vhen doneslic currency
depreciales.
d) Assels viz. Overseas Inveslnenls
RIC, LLIC, ICNR (), Noslro
aIances Iose vaIue vhen doneslic
currency appreciales.
The exchange rale risk has
proninenlIy surfaced since adoplion
of lhe oaling exchange rale regine ly
lhe vorId connunily afler faII of lhe
rellon Woods syslen in 1973. LarIier
lvo hxed exchange rale syslens
had narked lheir faiIure. 1sl vas lhe
goId slandard in vhich price of aII
currencies vere hxed againsl goId.
Afler faiIure of lhe goId slandard,
rellon Woods syslen energed in
1941 in vhich price of aII currencies
vere hxed in lerns of US doIIar. Il
aIso denised in 1972 giving rise lo lhe
presenl days exchange rale regine
i.e IIoaling Lxchange Rale Regine,
in vhich narkel forces delernine lhe
exchange rales vilh Ieasl sovereign
inlerferences. Of course fev counlries
Iike china are exceplions, vhich sliII
foIIov a hxed exchange rale regine.
The lasic principIe governing lhe
exchange rale in oaling regine is
Iurchasing Iover Iarily (III).
According lo III an idenlicaI laskel
of goods shouId cosl equaI in differenl
counlries, given lhe exchange rale.
Il neans if one appIe cosls Rs. 5O in
India and $1 in USA, lhen USD/INR
exchange rale has lo le 5O in principIe.
Il nay le furlher affecled ly denand-
suppIy or/and specuIalive faclors.
Since prices of goods in differenl
counlries keep on changing suljecl
lo varied inalionary forces and lhe
denand-suppIy or/and specuIalive
faclors keep on pIaying lheir roIes, lhe
exchange rales have lecone a dynanic
phenonenon. This dynanisn gives
lirlh lo lhe Lxchange Rale Risk. Il
inpIies lhal vaIue of ones forex
exposures are suljecl lo change lased
on lhe aforenenlioned faclors, and in
lodays age of inlervoven econonies,
advanced lechnoIogy and vilranl and
Iarge forex narkels, exchange rales
ucluale every second. The voIaliIe
nalure of lhe IORLX narkel poses
a greal risk of sudden and draslic
IORLX rale novenenls, vhich nay
cause signihcanlIy danaging hnanciaI
Iosses fron olhervise prohlalIe
IORLX lransaclions.
MItIgatInn/HcdgIng nf thc
Exchange Rate Risk
Since lhe exchange rale risk is a
najor delerrenl in expansion of lhe
InlernalionaI usinesses, il needs
lo le properIy niligaled in order lo
nininise lhe inpacl of exchange rale
uclualions on lhe I/L and laIance
sheels. The prinary oljeclive of IORLX
risk nanagenenl is lo nininize
polenliaI currency Iosses, and nol
lo nake prohls fron IORLX rale
novenenls vhich are unprediclalIe
and frequenl. There is a vide array of
derivalive producls in lhe narkel for
effeclive nanagenenl and hedging of
exchange rale risk. Iev of lhen are
expIained hereunder:
a) Forex Forward contracts: These
are liIaleraI conlracls lelveen
lvo parlies lo luy/seII foreign
currency al a pre-specihed fulure
dale al a pre-specihed rale. Wilh
lhis one can Iock lhe exchange
rale and prevenl lhe exposures
againsl any fulure exchange rale
ucluaIlion. LxanpIe:
l) Currency Futures: These are
Lxchange lraded slandardized
forvard conlracls vhere exchange
53
Industry Insights
acls as cenlraI counlerparly
lo lolh uyer and seIIer. This
lakes avay lhe counlerparly and
sellIenenl risks as veII, olher
lhan lhe exchange rale risk. The
slandardized lerns in lhe conlracl
are for Quanlily of IORLX,
Lxpiralion Dales of Conlracl,
DeIivery Ieriod and Localions,
Iaynenl and SellIenenl lerns,
and Unils of Irice IIuclualions.
c) Currency Options: Currency
oplion is a hnanciaI conlracl
lelveen lvo parlies lhal provides
lhe luyer vilh lhe righl (vilhoul
an olIigalion) lo luy/ seII a
parlicuIar currency al a pre
specihed price al a fulure dale. The
righl lo luy is CaII Oplion vhereas
lhe righl lo seII is Iul Oplion. An
oplion is a non-Iinear derivalive
lhal hoIds onIy lhe upside for lhe
luyer. Il neans lhal lhe luyer of
an oplion nay exercise his oplion
if il is in lhe noney, eIse he nay Iel
il expire vilhoul leing exercised.
The price of onIy having an upside
and no dovnside, is reecled in
lhe preniun of lhe oplion.
Il is evidenl fron lhe alove graphs
lhal polenliaI Iosses arising oul of
an oplion conlracl are reslricled
lo lhe anounl of preniun onIy,
vhereas lhe polenliaI gains are
lheorelicaIIy unIiniled.
d) Cross Currency Swaps: A
Cross currency svap (CCS) is a
derivalive conlracl ly vhich lvo
counlerparlies exchange, over
an agreed period, lvo slreans
of inleresl paynenls in differenl
currencies and, al lhe end of lhe
period, lhe corresponding principaI
anounls al an exchange rale agreed
al lhe slarl of lhe conlracl. Il heIps
hedging of foreign currency Ioans
and inveslnenls of residenls.
2) Interest Rate Risk: Inleresl rale
risk is lhe risk (varialiIily in vaIue)
lorne ly an inleresl-learing assel
(Inveslnenls) or IialiIily (lorrovings)
due lo varialiIily of inleresl rales.
Relurn on assels (overseas Ioans &
inveslnenls) decreases vilh decrease
in overseas inleresl rales and vice versa.
Cosl of IialiIilies (LCs) increases vilh
increase in overseas inleresl rales. The
currencies vilh Iover inleresl rales
are lraded al preniun in lhe forvard
narkel and vice versa. The forvard
IndIa Tradc wIth AsIa (In $ bn)
Forex Exposure
Lxporler lo Luro zone viII receive LUR 1 nio in 3 -
nonlhs
Spol rale LUR/INR: 59.77, Lxporler leIieves Rupee -
viII appreciale againsl Luro in lhe nexl 3 nonlhs
Hedging Instrument
Lxporler seIIs LUR 1 nio forvard al forvard rale of 6O.15 -
If LUR/INR is unfavoralIe in 3 nonlhs (i.e., < 6O.15), -
Lxporler sliII receives Rs. 6O.15 per Luro, lhal is Rs. 6O.15
nio
Unhedged Company
If in 3 nonlhs, spol rale is 58.OO. -
- Unhedged Conpany viII receive:
- 58.OO x 1,OOO,OOO =
- Rs. 58,OOO,OO
Effect of Hedging
Hedged Conpany has aIready soId LUR forvard -
- Hedged Conpany viII receive:
- 6O.15 x 1,OOO,OOO = Rs. 6O,15O,OOO
Money saved by hedging: 60,150,000 58,000,000 = Rs 2.15 mio
Graphical Representation of Currency Option Payoffs
54
Industry Insights
preniun decreases (increases) vilh
increase (decrease) in lhe inleresl rales
of lhe currency al preniun.
MItIgatInn/HcdgIng nf thc
Interest Rate Risk
Mosl proninenl derivalive
inslrunenl lo hedge lhe Inleresl rale
risk in a forex exposure is Inleresl Rale
Svap (IRS). An inleresl rale svap is
a derivalive conlracl in vhich one
slrean of inleresl paynenls (Iixed or
oaling) is exchanged vilh anolher.
3) Cnuntry/5nvcrcIgn RIsk: Counlry
risk refers lo lhe risk of doing lusiness
in a foreign lerrilory or vilh foreign
nalionaIs, dependenl on changes in lhe
lusiness environnenl and poIicies lhal
nay adverseIy affecl operaling prohls
or lhe vaIue of assels. Many counlries
foIIov a ligger inlervenlionisl roIe
crealing uncerlainlies and risks in
lhe narkel. They nay frequenlIy
lanper lhe exchange rales or lhe
currency converliliIily (currenl or
capilaI accounl) poIicies inpacling lhe
prohlaliIily of lhe lusiness.
MItIgatInn/HcdgIng nf
Sovereign risk
The sovereign risk can le niligaled
ly conhning our lusinesses and forex
exposures in poIilicaIIy slalIe counlries
and reslricl our lransaclions covered/
guaranleed under/ly inlernalionaI
lrealies/organisalions/lanks.
4) Compliance Risk: ConpIiance risk
refers lo lhe expecled Iosses/ penaIlies
arising due lo non conpIiance of
reguIalory guideIines. The foreign
exchange narkel is conlroIIed and
reguIaled ly a nunler of agencies
vhich enhances lhe conpIiance risk
nanifoIds.
a) RI: Il reguIales lhe IORLX
narkel lhrough parlicipanls and
producls.
l) ILMA (2OOO): Il Iays dovn delaiIed
guideIines on pernilled capilaI &
currenl a/c lransaclions as veII as
InlernalionaI Renillances.
c) DCIT (MOC): Il franes lhe Ioreign
Trade IoIicy.
d) ILDAI: Il does lhe Accredilalion
of Iorex rokers and franes ruIes
governing lhe conducl of inler-
lank foreign exchange lusiness
anong lanks vis-a-vis pulIic.
compliance risk
The conpIiance risks are niligaled
ly carefuI and inforned lusiness
praclices and efhcienl processes.
5) Settlement risk: SellIenenl Risk
refers lo lhe risk of Iosses arising oul
of non receipl of funds as per agreed
lerns. Since forex narkels are virluaI
narkels spread round lhe gIole, one
parly lo an IX lrade couId pay oul
lhe currency il soId lul nol receive
lhe currency il loughl. This is caused
nainIy due lo differenl line zones in
various counlries. If you lrade YLN
(ank of Tokyo in }apan) againsl USD
55
Industry Insights
(Cililank in USA) silling in India,
vilh a difference of 15-16 hours lhe
sellIenenl nay lake pIace on differenl
dales.
settlement risk
SellIenenl risk can le niligaled ly
proper assessnenl of sellIenenl
nelhodoIogy, efhcienl processes and
error free operalions. Conlinuous
Iinked sellIenenl (Iaynenl vs.
Iaynenl) is lhe oplinaI nelhodoIogy
lo hedge lhe sellIenenl risk.
Summary and Conclusion
Risk and Revard are lvo facels of
lhe sane coin. Lvery lusiness has
Inherenl risks vhich nay differ
depending on ils operalions, aclivilies
and lhe underIying risk faclors.
usiness is acluaIIy an arl of laking
risks and gelling conpensaled for
il. Risk nanagenenl doesnl nean
avoiding risk. Il focuses lo oplinize
risk-revard lrade-off ralher lhan
nininize/eIininale risk. Since
IORLX lransaclions cross nalionaI
loundaries, il invoIves nuIlipIe sel
of nacro and nicro econonic faclors
spread over differenl counlries. Il
yieIds unique and conpIex risks vhich
are generaIIy unnanagealIe vilhoul
hedging lhrough lhe derivalive
producls. AIlhough, IX derivalives
are nagnihcenl risk nanagenenl
looIs enalIing lhe inveslors lo prolecl
lhenseIves fron lhe vagaries of lhe
voIaliIe IX narkels, il nay prove lo
le disaslrous if used vilhoul proper
underslanding. So need of lhe hour is
lo educale ourseIves vilh lhe vilranl
derivalive producls and parlicipale
effecliveIy in lhe derivalives narkel lo
heIp il evoIve lo ils oplinun IeveIs.
The need of the hour
is to educate ourselves
with the vibrant
derivative products
and participate
effectively in the
derivatives market to
help it evolve to its
optimum levels
Usha Ananthasubramanian
Executive Director
Punjab National Bank
Snl. Usha Ananlhasulrananian has laken over as Lxeculive Direclor of
Iunjal NalionaI ank on 19lh }uIy 2O11. Irior lo joining lhe ank, she vas
CeneraI Manager in ank of aroda. orn on 1sl Ocloler 1958, Snl. Usha
hoIds a Maslers Degree in Slalislics fron lhe Universily of Madras and a
Maslers degree in Ancienl Indian CuIlure fron Universily of Munlai.
She slarled her lanking career in Ielruary 1982 as a SpeciaIisl Ofhcer in lhe
IIanning slrean of ank of aroda. In a career spanning over 29 years, she
has vorked in various posilions and has acquired rich experience. The key
assignnenls incIude ZonaI Head of Soulhern Zone of ank of aroda, Life
Insurance }oinl Venlure fornalion and Secrelary lo lhe oard of Direclors.
She has leen cIoseIy associaled vilh lhe lransfornalion projecl of ank of
aroda incIuding relranding and innovalive HR inilialives.
Snl. Usha has allended Leadership DeveIopnenl Irogranne al MDI,
Curgaon, Leadership & Corporale LxceIIence Managenenl Irogranne al
KeIIogg SchooI of Managenenl, Norlhveslern Universily, Chicago. and lhe
Top Managenenl Irogranne al Indian SchooI of usiness, Hyderalad.
56
Industry Insights
I
oreign Lxchange Risk has
gIolaIIy cone lo proninence
since lhe aloIilion of lhe rellon
Woods syslen of adninislering
exchange rales in 1971. Under rellon
Woods, nalionaI currencies vere
pegged lo lhe US DoIIar, vhich in
lurn vas pegged lo goId al $35 per
ounce of goId. y lreaking ils peg lo
CoId, US lroke up lhe rellon Woods
syslen of hxed exchange rales,
naking lhe currencies oal freeIy.
This Iefl corporales havingcross
lorder exposures vilh a high risk
of uncerlainly in cash ovs, prohls
as veII as fulure cosls. Since lhen
foreign exchange risk nanagenenl
has lecone an inporlanl lopic of
deIileralion and ve have seen lanks
cone up vilh nuIlipIe looIs for
hedging lhese risks ly corporales.
Domestic Scenario
In India, liII nid-sixlies, Rupee
vas reasonalIy slalIe and pegged
lo Iound SlerIing. Hovever, lrade
and hscaI inlaIances and prevaiIing
circunslances varranled a sleep
devaIualion of Rupee in 1966. In lhe
foIIoving period, afler experinenling
vilh pegs lo differenl currencies, India
pegged Rupee lo a laskel of currencies
of najor lrading parlners.
Inspile of lhese neasures and a
conlinuousIy veakening Rupee,
India again had a serious laIance of
paynenls crisis lhal Ied lo lhe reforns
of 1991 vhich aIso incIuded successive
sharp devaIualions of lhe Rupee in }une
1991. The process of fuII converliliIily
on currenl accounl for Indian Rupee
slarled in 1992. ul lhe exchange rale
vas kepl slalIe under LileraIized
Shri Nishant Jha, Vicc Prcsicn| (Rcscarcn)
Shri Selvaraj Kalyanasundaram, Dcpu|q Gcncra| Managcr
(|crcx, |inancia| |nginccring c Ncu Prcuc|s)
Human beings, who
are almost unique in
having the ability
to learn from the
experience of others,
are also remarkable
for their apparent
disinclination to do
so.
....Dcug|as Aams
57
Industry Insights
Lxchange Rale Managenenl Syslen
(LLRMS) and lhen a unihed exchange
rale nechanisn lelveen 1993 and
1995. Rupee conlinued ils graduaI
deprecialing lendencies againsl lhe
US DoIIar afler lhe vilhdravaI of lhe
unihed exchange rale.
In lhe nev niIIenniun, Indian
lrade has grovn ly Ieaps and lounds.
Indian lusinesses have slarled lo
generale signihcanl revenues fron
lheir overseas operalions. Inveslors are
aIso hnding vaIue in lheir inveslnenls
in India. This has crealed a Iarger
narkel lase for Rupee Ieading lo
higher voIunes. Rupee exchange rale
has lhus leen given nore Ieevay lo
hnd ils ovn vaIue, nolivaling Indian
corporales lo lake up risk nanagenenl
in a nore focused nanner. Nov lhal
Rupee has lraced lvo vay novenenls
of Iarger degrees exchange rale risk
nanagenenl has lecone of ulnosl
inporlance even for corporales vho
have kepl a passive slance lovards
exchange rale risk nanagenenl.
India Highly Exposed to
Exchange Rate Fluctuations
In Novenler 2O12, India had a
nerchandise lrade dehcil of $19.287
liIIion or Rs. 1,O5,647 crores. Oul of
around $64 liIIion lrade voIunes in
Novenler ($41.59 liIIion inporls),
$14.52 liIIion vas conlriluled ly oiI
inporls, naking il 35 of Indias
inporls, and around 23 of lolaI lrade
voIunes.And lhe even nore vorrying
lil is lhal oiI inporls grev al 16.77
over previous year in Novenler.
In addilion, goId has energed as
a nev shock lo lhe Indian currenl
accounl. Lasl hscaI ve inporled $58
liIIion vorlh of goId, conpared lo
$14O liIIion vorlh of oiI. The currenl
accounl dehcil in lhis hscaI is IikeIy lo
end up alove 4.5 of CDI.
Wilh goId and oiI inporls pulling
pressure on Rupee lo depreciale, RI
has lried lo aIIov a nunler of vays lo
increase capilaI inovs. An increasing
nunler of conpanies have leen
aIIoved lo lorrov alroad and foreign
inveslors lo invesl in India lo counler
lhe negalive lrade ovs. IIIs can nov
invesl uplo $75 liIIion inlo lhe Indian
dell narkels. This is in addilion lo
lhe Iarge hoIdings of IIIs in Indian
slock narkels vorlh nore lhan $23O
liIIion.Any shake up in conhdence can
quickIy see Iarge oulovs fron India,
Ieading lo a sharp deprecialion of lhe
Rupee.
Since 2OO7, Rupee has lraded
lelveen a vide range of 57.33-39.21,
vhich is a 46 change lelveen lhe
Iovesl IeveI lo lhe highesl. During
lhe sane period lhe change lelveen
Iovesl and highesl vaIue of LUR/USD
has leen 35, vhiIe lhe sane for Yuan
is jusl 15.
Sources of Risk for
Corporates
Indian corporales are exposed lo
lhe risk of Iosses due lo exchange rale
uclualions lhrough various channeIs.
The nosl olvious of lhese is lhrough
lradeexposures. This channeI of risk
exposure is veII recognized in India,
lhough nosl corporales sliII do nol
hedge even lhese exposures. This
nay incIude sinpIe lusiness exporls/
inporls, capilaI expendilures in foreign
currency Iike inporl of nachinery
and/or revenues in foreign currency.
Such exposure nay aIso incIude olher
incone, such as royaIlies, inleresl,
dividends elc. received in foreign
currency.
Ior exporlers, exchange rale
uclualions can le delrinenlaI lo
lhe nargins or in exlrene cases
even lo lhe vhoIe lusiness as an
apprecialion of Rupee can Iead lo
reduced conpeliliveness or even non-
vialiIily of connilled orders. Anolher
source of exposure lo exchange rale
risk for Indian corporales is due lo
lheir non-Rupee lorrovings lhrough
LC/ICC roule. RecenlIy ve have
seen nany corporales having lroulIe
vilh repaynenl of lheir ICC/LC
lorrovings due lo Rupee veakness.
Lven lhose corporales vho vere alIe
lo repay lheir lorrovings have leen
hil due lo exchange rale novenenl.
A corporale couId aIso le exposed
lo exchange rale risk in case il has
offshore assels such as operalions or
sulsidiaries lhal are vaIued in a foreign
currency (lransIalion exposure).
The olher lvo channeIs lhal expose
Indian corporales lo exchange rale risks
are Iesser knovn, even lhough lhey
are quile prevaIenl. Many conpanies
assune doIIar IialiIilies using svaps
Ieavinglhen open lo exchange rale
risk in case lhere is no naluraI hedge.
SiniIarIy, nany corporales prefer
lo use cosl reduclion slruclures in
pIace of sinpIe forvards lo reduce
lheir hedging cosls. This aIso exposes
lhen lo exchange rale risks for lhe seII
oplion Ieg of lhe slruclure as vriling of
an oplion creales an olIigalion. Risks
arising lhrough lhese lvo channeIs
aIso need lo le considered vhiIe
considering lolaI exposure lo foreign
exchange risks.
Exchange Rate Risk
Management
Il is an accepled facl lhal currency
exchange rales are nol prediclalIe
lo any salisfaclory degree. Civen lhe
Iarge nunler of vays in vhich a hrn
can le exposed lo exchange rale risks,
il is inperalive lo consider nanaging
lhese risks. Managenenl of exchange
rale risk invoIves a nunler of sleps
for a corporale, Iike recognizing lypes
of exposures, caIcuIaling lhepolenliaI
vaIue of exposure as veII asconlroI
and niligalion of lhe risk due lo lhese
exposures.
To ensure lhal a syslen of exchange
rale risk nanagenenl is in pIace,
especiaIIy afler lhe dispules lhal arose
afler lhe 2OO8 hnanciaI crisis, RI has
pul in pIace a cusloner SuilaliIily and
Approprialeness IoIicy lo le foIIoved
ly lanks. The poIicy inslrucls lanks
lo nake sure lhal lhe corporales have
a loard approved Risk Managenenl
IoIicy.
Risk Measurement
One of lhe nosl videIy used
neasures of currency risk is VaIue
58
Industry Insights
al Risk or VAR. VAR gives us lhe
naxinun change for a specihed
nunler of days and for a specihed
conhdence IeveI. WhiIe VAR can le
caIcuIaled in a nunler of vays, one of
lhe sinpIesl vays is expIained leIov:
We lake hisloricaI cIosing prices
of USD/INR fron 2OO8 lo 2O12 and
lhen caIcuIale daiIy relurns using
lhe fornuIa In(p2)-In(p1), vhere p1
is cIosing price on a day and p2 is
lhe cIosing price on lhe nexl day.
Then ve caIcuIale lhe nean (n) and
lhe slandard devialion (sd) of lhese
relurns. The 1-day 99 conhdence
VAR for lhis is caIcuIaled as:
VAR (V) = m-2.33sd
To caIcuIale lhe range of possilIe
vaIues, ve need anolher dala, lodays
price (p). Then lhe fornuIa for 1-day
change in exchange rale can le
caIcuIaled using lhe fornuIa:
1-day changc = p(1+V) nr p(1-V)
Ior a 1O-day change, ve jusl need lo
nuIlipIy lhe 1-day VAR vilh square
rool of 1O, and for 1OO-day change vilh
square rool of 1OO, and so on. We use
lhis lo caIcuIale lhe 99 conhdence
VAR for USD/INR using cIosing prices
dala fron 2OO8-2O12 and currenl price
as 55.15 leIov:
These hgures shov lhal 1OO days
fron nov USD/INR can le lelveen
58.34 and 51.96 vilh a 99 conhdence.
This sliII Ieaves a 1 chance of lhe
Rupee lrading leyond lhis range.
AcluaIIy, lhis nodeI assunes a nornaI
dislrilulion for lhe relurns, vhich
is a leII curve. In reaIily, lhe relurns
dislrilulion curve is Iike lhe one given
leIov. This is aller lhan a nornaI
curve vilh faller laiIs. This neans
lhal lhe chances of USD/INR lrading
leyond lhis range in lhe nexl 1OO
days are nore lhan jusl 1. To gel a
leller range eslinale, lhere are fal laiI
adjuslnenls lhal can le used.
Nov lhal lhe naxinun and
nininun vaIue of lhe exchange rale
has leen derived, ve can use lo easiIy
caIcuIale lhe risk. Say our exposure is
one niIIion USD Iong al lhe currenl
price. Then our risk on lhis posilion is
approxinaleIy 3.19 niIIion Rupees or
$57,842 (55.15-51.96=3.19).
Risk Control and
Mitigation Hedging
RI aIIovs lanks lo provide various
hedging looIs lo lheir cusloners Iike
Iorvard conlracls, Svaps, Oplions
and Currency Iulures.SeIeclion of
a parlicuIar hedging inslrunenl ly
a corporale vouId depend upon
avaiIaliIily, exiliIily and cosl. Mosl
connon anong lhese looIs in India
for hedging are lhe forvard conlracls
given lheir high ralings on aII lhree
paranelers. Mosl Iarge corporales
lypicaIIy use a conlinalion of lhese
hedging looIs lo hedge lheir various
exposures, depending, in addilion lo
lhe alove noled paranelers, on lheir
viev of lhe currency novenenl going
forvard, expecled ovs, elc. anks
are aIso inslrucled ly RI under
lhe SuilaliIily and Approprialeness
IoIicy lo judge lhe approprialeness of
a cusloner and ensure proper oard
approvaIs for lhe producls lhal nay
le offered lo a corporale.
In India ve sliII see a Iol of
reIuclance lo address lhe issue of
foreign exchange risk ly corporales
inslead of lhe Iarge nunler of vays in
vhich il can inpacl lhen. Many hrns
are sinpIy nol sensilized of lhe risks,
especiaIIy snaII and sone nediun
sized hrns.Olhers are avare of lhe
risks lul do nol knov hov lo hedge
lhe risks. There are aIso hrns vho Iike
lo onIy hedge parl of lheir risks and
sliII olhers vho feeI lhal hedging is
loo expensive and il is leller lo Ieave
lhe exposures open. Iurlher, zero
cosl or cosl reduclion slruclures are
very popuIar lo reduce lhe hedging
cosl, lul such slralegies do nol cone
vilhoul lheir ovn risks as lhey invoIve
vriling of oplions. OnIy sophislicaled
Iarge lreasuries shouId vrile oplions,
under lhe ruIes prescriled ly RI,
vhiIe snaIIer Iess savvy corporales
need lo pay for lhe hedge. Moreover,
Corporales shouId le sensilised lo
avoid use of slruclured producls for
prohl naking purpose. Il shouId le
used slriclIy for hedge purpose.
Conpanies shouId lroadIy lry
lo hnd a lreak even exchange rale
lased on lheir cosling and lhen hedge
lhe risk afler accounling for sone
nargin. This nay nol le sinpIe in
Nunler of Days 1 1O 1OO
VAR O.OO5778 O.O1827 O.O57775
Maxinun 55.47 56.16 58.34
Mininun 54.83 54.14 51.96
59
Industry Insights
case of cerlain seclors and in cerlain
condilions, lul is usefuI as a lhunl
ruIe lo nake a decision. They aIso
need lo lake a decision, again lased
on induslry specihc faclors, on lhe
oplinaI hedge for lheir exposure. Ior
exanpIe, a cerlain hrn nay decide
lo hedge in parls, especiaIIy in case
of prolalIe exposures, vhiIe anolher
nay decide lo go for a one line hedge.
Once lhe hedging is done lhe hrn
shouId nol see favouralIe exchange
rale novenenl as a Iosl opporlunily.
ul here il is inporlanl lo nole lhal
parliaI exposures or even incorrecl
hedging can Ieave a hrn open lo
exchange rale risks and in sone cases
even creale addilionaI exposures. So
choosing an oplinaI hedging slralegy
shouId le given due inporlance in
any corporale vilh foreign exchange
exposures.
Hedging Products in India
RI has specihed (CircuIar daled
28lh Decenler 2O1O - Conprehensive
CuideIines on Over lhe Counler (OTC)
Ioreign Lxchange Derivalives and
Overseas Hedging of Connodily Irice
and Ireighl Risks) vhich enlily can
access vhal producls for hedging lheir
exchange rale risks. The faciIilies are
divided lased on producls/purpose:
Conlracled Lxposure: Iroducls 1.
aIIoved are Iorvard Ioreign
Lxchange Conlracls, Cross
Currency Oplions (nol invoIving
lhe Rupee), Ioreign Currency-
INR Oplions,Ioreign Currency-
INR Svaps, Cosl Reduclion
Slruclures, Cross currency svap,
Inleresl Rale Svap, Coupon
Svap, Inleresl Rale Cap or
CoIIar(purchases), Iorvard Rale
Agreenenl
IrolalIe Lxposures lased on 2.
Iasl Ierfornance: Iroducls
aIIoved are Iorvard Ioreign
Lxchange Conlracls, Cross
Currency Oplions (nol invoIving
lhe Rupee), Ioreign Currency-
INR Oplions, Cosl Reduclion
Slruclures
SpeciaI Dispensalion: IoIIoving 3.
are pernilled under speciaI
dispensalion:
a. SnaII and Mediun Lnlerprises
(SMLs): Iernilled lo look
forvard foreign exchange
conlracls vilhoul produclion of
underIying docunenls. Iroducls
aIIoved is onIy Iorvard Ioreign
Lxchange Conlracls
l. Residenl IndividuaIs: Can
hedge acluaI or anlicipaled
exposure vilhoul underIying
docunenls uplo USD 1,OO,OOO
Iersons residenl oulside India: 4.
Ioreign InslilulionaI Inveslors
(IIIs), Iersons having Ioreign
Direcl Inveslnenl (IDI) in India
and Non-residenl Indians (NRIs)
can use Iorvard Conlracls and
Ioreign Currency-INR Oplions
Aulhorised DeaIers Calegory I: 5.
Can hedge for nanagenenl of
assels and IialiIilies, hedging of
goId price risk and hedging of
currency risk on capilaI
According lo RIs Masler CircuIar
on Risk Managenenl and Inler-ank
DeaIings, lhe foIIoving producls are
aIIoved for hedging foreign exchange
risk in India:
Iorvard conlracls: Can le done 1.
for nalurily nol exceeding lhe
exposure nalurily, and for
an anounl uplo lhe exposure
anounl, or a reasonalIe assunp-
lion. WhiIe forvard conlracls are
very exilIe al lhe line of nak-
ing lhe conlracl in lerns of lhe
anounl, nalurily dale (lhough
cosls of conlracls vilh nalu-
rily nol on end of nonlh nay le
nore), pricing lransparency, elc.,
lhey are linding al lhe nalurily.
Currency Oplions: SiniIar 2.
reslriclions as forvard conlracls
in lerns of nalurily and anounl.
The pricing lransparency is Iess
lhan forvards as lhe narkel
is nol acliveIy lraded in India,
lul il provides nore exiliIily
al nalurily as il creales a righl
and nol an olIigalion lo execule
lhe conlracl, Ieaving lhe possilIe
Companies should
brnad!y try tn nd a
break even exchange
rate based on their
costing and then
hedge the risk after
accounting for some
margin
60
Industry Insights
upside vilh lhe hedger. ul lhe
exiliIily cones vilh a higher
cosl of hedging. Ior nov onIy
pIain vaniIIa Luropean oplions
are aIIoved, aIong vilh sone
of lheir conlinalions. Lxolic
oplions and olher fealures Iike
larriers elc. are nol pernilled
ly RI anynore. RI aIso does
nol aIIov corporales lo receive
preniun, lul hedging cosls nay
le reduced using cosl reduclion
slruclures as Iong as lhe lank is
conforlalIe vilh lhe suilaliIily
of lhe corporale lreasurys aliIily
lo nanage a vrillen oplion
exposure. Inleresl rale caps and
coIIar purchases are aIso aIIoved
for hedging lorrovings in foreign
currency.
Iulures: SiniIar lo forvard 3.
conlracl, excepl lhal an iniliaI
nargin needs lo le pIaced vilh
lhe exchange. The posilion MTMs
are sellIed on a daiIy lasis. A
najor veakness of fulures as
a hedging producl is lhal lhey
cannol le laiIored in lerns of
anounl or nalurily dale.
Svaps: Svaps are anong lhe 4.
nosl popuIar derivalive conlracls
due lo lheir vide usefuIness and
Iov cosl. RI aIIovs ICY-INR
svaps for hedging forex risks and
cross currency svaps, inleresl
rale svaps and forvard rale
agreenenls (IRAs) for hedging
lorrovings in foreign currency.
AIong vilh lhe anounl of exposure,
RI aIso aIIovs corporales lo hedge
exposures lased on pasl perfornance,
vhich is lased on pasl perfornance
up lo lhe average of lhe previous
lhree hnanciaI years acluaI exporl
lurnover or lhe previous years acluaI
exporllurnover, vhichever is higher.
Ior inporls, lhe ruIe is lhe sane excepl
lhal onIy 25 of lhe eIigilIe lurnover
anounl is aIIoved lo le hedged. Ior
such hedges, lanks are nol aIIoved lo
pass on any gains on any canceIIalions
lo corporales.
Documentation - ISDA
Master Agreement and
CSA
RIs Derivalive CuideIines
nenlion lhal docunenlalion shouId
le conpIele in aII respecls lelveen
parlies enlering inlo derivalives
conlracls. This has lecone even nore
inporlanl afler lhe prolIens faced
in sellIenenls in lhe aflernalh of lhe
Lehnan rolherslankruplcy. Ior
reducing lhe docunenlalion efforls
during each deaI and lo nininise any
dispules lhrough slandardisalion,
ISDA Masler Agreenenl shouId
le signed ly corporales vilh lhe
lanks lhey vanl lo do derivalives
conlraclsvilh, incIuding for forvard
conlracls vhere lhe lenor exceeds 13
nonlhs. The Masler Agreenenl aIIovs
enough exiliIily vhiIe aIso providing
a gIolaIIy slandardised fornal for lhe
docunenlalion so lhal dispules and
disagreenenls are nininised.
The CSA, or Credil Supporl
Annexure, is an oplionaI parl of
lhe ISDA Masler Agreenenl vhich
reguIales credil supporl or coIIaleraI
for derivalive lransaclions. This is nol
yel popuIar in India as lanks lend lo
use lheir narked-lo-narkel Iinils for
cusloners lo nanage lheir credil risk
and posling coIIaleraI is nol popuIar
in lhe OTC derivalives narkel here.
Making lhe use of CSAs aIong vilh
ISDA Masler Agreenenls can Iead lo
a reduclion in hedging cosls.
Move Towards
Transparency Exchange
Traded Products and CCPs
In Seplenler 2OO9, C2O Ieaders
agreed aII slandardised OTC derivalive
conlracls le lraded on exchanges or
eIeclronic lrading pIalforns, vhere
appropriale, and cIeared lhrough
cenlraI counler-parlies (CCIs), lhal
OTC derivalive conlracls le reporled
lo lrade reposilories, and lhal non-
61
Industry Insights
cenlraIIy cIeared conlracls le suljecl
lo higher capilaI requirenenls.We
have seen lhe deveIopnenl on sone
of lhese areas, especiaIIy in selling up
reporling lo cenlraI reposilories vilh
CCIL leing deveIoped as a cenlraI
reposilory. RI has nandaled lanks
lo reporl aII derivalive deaIs lo CCIL.
In US, lhe WaII Slreel Transparency
and AccounlaliIily Acl(TilIe VII of
Dodd Irank) aIso pronoles cenlraI
cIearing and reporling lo reposilories
for svaps.
We have noslIy laIked aloul lhe ex-
posure of corporales lo USD/INR ex-
change rale uclualions, lul lhe sane
appIies lo exposures lo olher currency
pairs. Since nany corporales have ex-
posures in olher currencies, lheir risk
nanagers need lo foIIov lhe deveIop-
nenls across lhe gIole: vhelher il is
lhe Luro zone crisis, US hscaI negolia-
lions, geopoIilicaI evenls in lhe MLNA
(MiddIe Lasl and Norlh Africa) region
or Soulh China Sea, or lhe eIeclion of
a nalionaIisl governnenl in }apan. Ior
exanpIe, lhe Ialler has Ied lo 9 de-
precialion in Yen vilhin lvo nonlhs
of lhe announcenenl of eIeclions.
IinaIIy, il is inporlanl for lhe lop
nanagenenl lo le avare of lhe risk
nanagenenl funclions aclivily on a
reguIar lasis. In lhe end, I lhink lhis
quole fron Theodore RooseveIl niceIy
suns up lhe vay in vhich ve need lo
see risk nanagenenl:
Ris| is |i|c frc. |f ccn|rc||c i| ui|| nc|p
qcu, if unccn|rc||c i| ui|| risc up an c-
s|rcq qcu.
Nishant Jha
VIcc PrcsIdcnt (Rcscarch)
Shri Nishanl }ha, Vice Iresidenl (Research)
}oined Slale ank of India as Managenenl Trainee in 2OO6. He is an
engineering graduale in Conpuler Science fron Rajaslhan Universily
and an MA in Iinance fron Managenenl DeveIopnenl Inslilule,
Curgaon.
He has leen pulIishing Iorex Research for CIolaI Markels for lhe pasl
seven years.
Selvaraj Kalyanasundaram
Deputy General Manager
(Fnrcx, FInancIa! EngInccrIng &
Ncw Prnducts)
Shri SeIvaraj KaIyanasundaran, Depuly CeneraI Manager (Iorex,
IinanciaI Lngineering & Nev Iroducls)
}oined Slale ank of India as Irolalionary Ofhcer in 1985. Anong
lhe assignnenls he has handIed are DeaIer - Overseas ranch
Chennai, DeaIer - Irankfurl ranch, Chief Manager (InlernalionaI
anking) - Lealher InlernalionaI ranch, ranch Head - SI DIHI Lld.,
Chennai, Assislanl CeneraI Manager (Treasury Managenenl Croup) -
InlernalionaI Division, Munlai.
He vas acliveIy invoIved vilh lhe aclivilies of The Iixed Incone
Money Markel and Derivalives Associalion of India (IIMMDA) and
heId lhe posilions of Vice Chairnan and Chairnan lelveen Nov1O
and Iel12. Shri SeIvaraj currenlIy hoIds lhe posilion of Chairnan,
Iorex Associalion of India (IAI).
62
Industry Insights
A
s Asian dell and foreign
exchange narkels are sel lo
grov slrongIy vilh Asian
hnanciaI cenlres gelling nore focus,
il is leconing even nore perlinenl
lo nanage lhe foreign exchange risk
nore proacliveIy. The signihcance of
foreign exchange risk nanagenenl has
increased due lo severaI faclors.
India is nov nore open lo lhe
gIolaI econony vilh ils groving
lrade and hnanciaI inlegralion vilh
lhe resl of lhe vorId. The gIolaI IX
lurnover has lripIed lelveen 2OO1 and
2O1O. In India, lhe exporl and inporl
lurnover has lrelIed since 2OO6 (exporl
$3O5ln & inporl 489ln in IY2O12
as conpared lo $1O3ln and $149ln
in IY 2OO6 respecliveIy). The lolaI
nerchandise lrade has lhus increased
lhreefoId lo USD 794 lIn in 2O12. This
inpIies increased IX risk lo doneslic
corporales across various geographies
vilh Asia laking up a Iarge chunk
(51.6) cIoseIy foIIoved ly Lurope
(19), Norlh Anerica (11.9), Africa
(6.6)
1
.
AIso, lhe voIaliIily in IX narkels can
le allriluled lo lhe crisis in US & euro
zone vhich conlinues lo le high. WhiIe
severaI energing and deveIoping
econonies are graduaIIy relurning lo
higher grovlh, veak exlernaI denand
and conlagion risks fron advanced
econonies render lhen vuIneralIe lo
furlher shocks. Lead indicalors poinl lo
a nodesl hrning up in lhe nonenlun
of gIolaI grovlh over 2O13 if lhere is
hrn poIicy aclion in lhe Luro area and
lhe US
2
.
Mr. James Berry, Chief Infornalion Ofhcer,
India & Soulh Asia, Slandard Charled ank
The global FX
turnover has tripled
between 2001 and
2010
________________________________________________________________________________________________________
1
Source : Minislry of Connerce & Induslry, Covernnenl of India
2
Source : Various Research reporls incIuding lhe Super CycIe reporl of Slandard Charlered
63
Industry Insights
The INR has deprecialed quile
sharpIy and has lecone very voIaliIe
during lhe recenl period due lo a
hosl of faclors, lolh exlernaI as veII
as inlernaI. Of Iale, ve are seeing
a period of high voIaliIily in nosl
of lhe assel cIasses. RI had laken a
rafl of neasures in Decenler 2O11 lo
lackIe lhe high INR voIaliIily vhich
inpacled lhe lrading and hedging
voIunes. Hovever, lhe resuned
aclivily Ialer sav a pick up again
despile lhe conlinuing reslriclions.
The forvard narkels in India are
very Iiquid uplo one year. Hovever,
il is nol so leyond say one year or
lvo years. This Iiquidily risk can
le nanaged lo a cerlain exlenl ly
laking a shorl hedge liII lhe nalurily
of lhe underIying exposure. This
is aIIoved for, under lhe currenl
reguIalions, suljecl lo anounl and
lenor avaiIaliIily on lhe underIying
exposure.
The reguIalor has laken severaI
sleps lo slreanIine and supporl
lhe narkels such as i) inlroducing
currency fulures lrading, ii) reIaxing
curls on inlra-day posilion Iinils, iii)
aIIoving re-looking ly Corporale lo
lhe exlenl of 25, iv) aIIoving non
residenl enlilies lo hedge lheir Rupee
denoninaled invoices, v) hedging
Rupee LCs, vi) aIIoving shorl
lern roIIovers on pasl perfornance
faciIily, and vii) aIIoving exporlers
lhe exiliIily of addilionaI 15 days
leyond lhe nalurily dale of lhe
underIying ly 15 days, lo nane a
fev.
The RI reporl on currency and
hnance 2OO8-O9 - CIolaI IinanciaI
Crisis and lhe Indian Lconony slaled
lhal in lhe aflernalh of lhe sul prine
and lhe hnanciaI crisis of 2OO8/9,
severaI queslions vere raised vhich
incIuded, inler aIia, lhe funclioning
of lhe hnanciaI narkels and lhe
lransparency, lheir capacily lo price,
aIIocale and nanage risk efhcienlIy.
Civen lhe Iarge size of lhe narkel
for slruclured hnance producls and
over lhe counler (OTC) producls, lhe
delerninalion of lhe fair vaIue lecane
increasingIy difhcuIl lo ascerlain.
SulsequenlIy, lhe reguIalor issued
revised conprehensive guideIines
on deaIings in foreign exchange
derivalive conlracls and connodily
hedging, cIearIy slipuIaling producls
lhal are disaIIoved and specihc
producl reIaled requirenenls.
The reguIalors inlenlions are veII
inlended, naneIy lo curl specuIalion
and aIIov lhe derivalive producls
onIy for lhe purposes of hedging
againsl lhe underIying exposure
requirenenls of lhe cIienls. Ior
exanpIe, lhe hedges shouId onIy le
underlaken on lhe lack of genuine
underIying exposures lovards vhich
lhe cIienls are required lo sulnil lhe
underIying docunenls vilhin 15 days
of lhe deaI dale.
Anolher exanpIe of producl
reslriclion is lhe cosl reduclion or
zero cosl slruclures vhich can onIy le
underlaken suljecl lo pre condilions
such as aII producls lo le fair vaIued,
AS 3O-32 conpIiance, hnanciaI
discIosures, risk nanagenenl poIicy
approved ly lhe loard of direclors
elc.
Ior olher faciIilies Iike lhe pasl
perfornance, siniIar slruclure can
le deaIl provided lhe conpany has a
nininun nel vorlh of INR 2OO crores
and an annuaI exporl and inporl
lurnover exceeding INR 1OOO crores.
Anolher inporlanl slep laken ly lhe
reguIalor vas lo reslricl canceIIalion
and relooking as il vas olserved lhal
lhis vas leing used for specuIalive
purposes ralher lhan Iong lern hedge
or a viev.
The guideIines aIso nandaled
lhe lanks lo carry oul due diIigence
regarding user approprialeness
and suilaliIily of lhe derivalive
conlracls lo ensure lhal lhe corporale
underslands lhe nalure of risk
inherenl and have lhe requisile
risk franevork in pIace lo nonilor
and nanage lhe risk on an ongoing
lasis. The RI aIso cane oul vilh
specihc guideIines on generic and
slruclured derivalive producls. This
slipuIales narkel nakers underlaking
derivalive lransaclions, vilh a sense
of responsiliIily and circunspeclion
lhal vouId avoid, anong olher
lhings, nis-seIIing. Il furlher
slales lhal lhe lanks shouId offer
lhese producls onIy lo users vhere
lhese are consislenl vilh lhe users
lusiness, hnanciaI operalions, skiII
and sophislicalion, inlernaI poIicies
as veII as risk appelile
3
.
Wilh lhe Indian econony expanding
al circa 6 p.a, lhere is an increased
focus on IX risk nanagenenl.
Iurlher, IX IileraIisalion is expecled
over lhe nexl fev years. The
preIininary resuIls of lhe ank for
InlernalionaI SellIenenls (IS) 2O1O
TrienniaI CenlraI ank Survey shovs
lhal average daiIy lurnover in gIolaI
IX narkels vas USD 3.98lrn in ApriI
2O1O - a 221 increase since 2OO1, a
period vhen noninaI gIolaI CDI
aInosl doulIed and vorId lrade
increased 2.5 lines. 2
WhiIe CNY is expecled lo le lhe
faslesl-groving currency in lerns of
average daiIy lurnover, nirroring
lhe earIy and niddIe phases of C1O
currency deveIopnenl, olher Iarge
LM currencies, such as lhe INR and
RL, shouId aIso grov fasl Iron
2O1O-2O, lhe MXN, ZAR, RU and
TH are IikeIy lo experience siniIar
grovlh rales as lhe AUD experienced
________________________________________________________________________________________________________
3
Source : RI/2O11-12/243 Conprehensive CuideIines on Derivalives : Modihcalions
With the Indian
economy expanding
at circa 6% p.a, there
is an increased
focus on FX risk
management
64
Industry Insights
fron 2OO1-1O as lhe average lurnover
of lhese currencies pul logelher
coIIecliveIy has reached a reIaliveIy
high IeveI. 2
Indias narkel infraslruclure, lhe
reguIalor and narkel parlicipanls
need lo le prepared for lhis. A leller
underslanding of lhe need for IX risk
nanagenenl and funclioning of lhe
IX narkels and lhe associaled risks in
hedging inslrunenls lhal are avaiIalIe
in lhe narkel is lhe need of lhe hour.
RI has very righlfuIIy laken a Iol of
correclive sleps in lhis regard vhich
has lroughl aloul a greal degree of
discipIine in lhe narkel. Sone of lhe
lroad slipuIalions in lhis regard are as
leIov.
Corporale need lo gel lhe -
appropriale syslens in pIace lo
caplure, nonilor and accuraleIy
nanage lhe risks in various
inslrunenls Iike fulures and
oplions
Corporale need lo pul in pIace -
risk nanagenenl poIicies
cIearIy eslalIishing a syslen of
risk oversighl, inlernaI conlroIs
lo idenlify, assess, nonilor and
nanage risks associaled vilh
deaIing in derivalive hedging
inslrunenls.
Corporale need lo have a -
franevork for an underslanding
of lhe conpanys risk loIerances
and Iinils.
The risk nanagenenl poIicy -
shouId cIearIy Iay dovn
lhe guideIines on prudenl
accounling and discIosure
norns and nark lo narkel
posilions.
The risk nanagenenl poIicy -
shouId cIearIy slipuIale lhe
hedging slralegy and lhe
producls lhrough vhich lhe
conpany pIans lo hedge lheir
IX risk lhrough veII iIIuslraled
exanpIes such as scenario
anaIysis.
Various cerlihcalion require- -
nenls fron lhe slalulory au-
dilors of lhe conpanies on a
reguIar lasis vhich enlaiIs lhe
slalulory audilors cerlifying
lhe oulslanding exposure on aII
derivalive producls lo le vilh-
in lhe overaII underIying expo-
sure al any poinl of line.
AD (Aulhorized DeaIers) lanks -
shouId ollain specihc loard
resoIulion fron lhe corporales
vhich i) expIicilIy nenlions lhe
Iinil assigned ly lhe corporale
lo lhe lank, ii) lhe nanes and
designalion of lhe ofhciaIs of
lhe conpany aulhorized lo
underlake parlicuIar derivalive
lransaclions, iii) lhe nane of lhe
peopIe lo vhon lransaclions
shouId le reporled ly lhe lank,
anong olher requirenenls.
WhiIe lhe reguIalor has pul lhe
onus on ADs for lhe due diIigence,
lhe end user Corporales aIso have a
greal responsiliIily in lhis regard. The
reguIalions have lroughl aloul a greal
degree of discipIine, orderIiness and a
sense of responsiliIily in lhe narkel
vhich augurs veII for aII.
To sunnarise, effeclive risk
nanagenenl is aloul idenlifying
and nanaging lhe rool causes of
risk, ralher lhan lhe synplons. IX
risks viII aIvays exisl, and nanaging
lhen veII vilh lhe looIs ve have
avaiIalIe vilhin your pre-dehned risk
lhreshoIds and lhe reguIalions jusl
nakes good lusiness sense.
James Berry
ChIcf InfnrmatInn Ofccr,
India & South Asia,
Standard Charted Bank
}anes joined Slandard Charlered in London in ApriI 1997. An accounlanl ly
lrade, he has previousIy vorked in AuslraIia and lhe Uniled Kingdon in a
variely of Iinance and OperalionaI roIes in nanufacluring and lechnoIogy.
Since joining Slandard Charlered he has underlaken Iinance, OperalionaI and
Consuner anking posilions, vorking in London, Hong Kong and Singapore.
He Ied lhe CIolaI Sourcing group since 2OO7 and crealed a slruclured and
professionaI approach lo hov lhe ank approaches lhis inporlanl area. In his
currenl roIe as lhe Chief Infornalion Ofhcer, his najor responsiliIilies incIude
deveIoping and execuling vorId-cIass lechnoIogy and operalions slralegies
lhal drive lhe lusiness agenda.
65
Industry Insights
M
anaging narkel risks has
lecone a crilicaI inperalive
of every corporale lreasury.
This arlicIe presenls ny ovn personaI
viev on 'hedging of narkel risk,
and offers unsoIiciled advice on
hov risk nanagers shouId perhaps
approach lheir lhankIess lask of risk
nanagenenl.
Hedging of market risk
Wikipedia dehnes a hnanciaI hedge
as 'an inveslnenl posilion inlended
lo offsel polenliaI Iosses/ gains lhal
nay le incurred ly a conpanion
inveslnenl.
Nolice lhal lhis dehnilion does
nol inpIy lhal 'hedging reduces aII
hnanciaI risks - il nereIy inpIies
nore prediclaliIily, in lhe hedgers
cashovs. In praclise, hovever,
ve sonelines presenl 'hedging as
a panacea for aII risks - econonic,
accounling, conpelilive elc. So ve
oflen hear suggeslions lhal corporales
shouId 'hedge lheir narkel risk lo
faclors such as foreign exchange and
inleresl rales, and focus soIeIy on
lheir 'core lusiness. The inpIicalion
is lhal il is possilIe lo achieve a slale
of riskIess insured nirvana, ly sone
aslule 'hedging. A coroIIary is lhe
advice lhal corporales shouId nol
'specuIale, i.e. le liased ly a viev
on lhe underIying narkels. Again,
lhe inpIicalion is lhal having a viev
is unnecessary, since risks can le
negaled ly 'hedging.
UnforlunaleIy, a 'hedge - or hnding
a danpener lo underIying voIaliIily
in hnanciaI resuIls - is nol necessariIy
a favouralIe or even Iess risky
econonic oulcone for a praclilioner,
aparl fron lhe narrov and aInosl
Mr. Ananth Narayan G, Co-Head of WhoIesaIe anking,
Soulh Asia, Slandard Charled ank
I will never die for
my beliefs; because I
might be wrong
... 8cr|ran Russc||
66
Industry Insights
acadenic conlexl of increasing
cashov cerlainly. An exporler, vilh
underIying receivalIes in foreign
currency vouId le 'hedging her
exposures ly seIIing foreign currency
againsl INR in lhe forvards narkel.
WhiIe lhis vouId naluraIIy cryslaIIize
her receivalIes in INR, lhis does nol
nean her reIalive econonic risks have
reduced. If INR vere lo depreciale
sharpIy - as il did lelveen Augusl
2O11 and nov, our exporler vouId
le severeIy disadvanlaged vis-a-vis
any conpelilion lhal chose lo keep ils
foreign exchange risk open.
Whal aloul using insurance producls
such as oplions` SureIy, luying laiI
risk insurance ly vay of oplions
lruIy does reduce risk - perhaps ly
guaranleeing a oor on lhe dovnside,
and perhaps aIIoving parlicipalion
on lhe upside` WhiIe oplions can offer
nore variely of appropriale payoffs
lhan sinpIe forvards, lhey cannol
ensure reIalive hnanciaI veII-leing
under aII circunslances. Insurance
cones al a cosl, and rareIy are such
cosls negIigilIe. Acadenia provides
us vilh anaIysis such as lhe efhcienl
fronlier hypolhesis, vhich leIIs us lhal
choosing a cerlain hedge ralio can heIp
reduce voIaliIily of hnanciaI oulcones
over a Ionger lern. Lven lhis, hovever,
does nol nake a connilnenl on
ensuring conpelilive parily.
So is conpelilive hedging lhe
righl 'hedging slralegy` ShouId our
CIO valch vhal her conpelilion
is doing, and lry and ninic lhen,
so lhal no conpelilive price/ cosl
advanlage accrues lo anyone` The
prolIen in lodays conpIicaled and
inlerconnecled vorId, is acluaIIy lrying
lo dehne vho lhe conpelilion is. Is il
lhe conpany nexl door, or are lhere
severaI possilIe diverse conpanies,
incIuding possilIe sulslilules lo lhe
conpanys cIienl soIulions, across lhe
vorId`
Lach one of us, lo varying degrees,
is perhaps guiIly of using 2O-2O
hindsighl vision lo 'predicl lhe pasl.
We have leraled inporlers and
lorrovers in foreign currencies for
nol having sufhcienlIy 'hedged lheir
IX risk ly luying USD 18 nonlhs ago,
vhen USDINR vas in lhe 45.OO range.
Afler aII, 'hedging is aIvays lhe righl
lhing lo do, ve seen lo inpIy. So,
vhal aloul exporlers, vho hedged
vhen USDINR vas al 45.OO - do ve,
for consislency, in lurn praise lhen`
We shouId recognise lhal in narkels
Iike India, vilh reIaliveIy snaII risk
size, of hnanciaI narkel pIayers
(lesides lhe RI!), for every reaI seclor
hedge lhal invoIves luying of foreign
currency, lhere viII le a laIancing reaI
seclor seIIing of foreign currency.
ReaIily is lhal slakehoIders - inlernaI
and exlernaI - viII neasure lhe quaIily
of a risk nanagenenl slralegy ly lhe
reIalive relurn il evenluaIIy produces.
A CIO/ Treasurers jol is quile
lhankIess in lhal sense - lhe earIier
lhe CIO recognizes and reconciIes
lo lhis, and dehnes her response as
'Risk Managenenl as opposed lo
'Hedging, lhe leller.
In addilion lo gelling an acceplalIe
reIalive relurn fron lhe narkel, lhe
CIO aIso has lo nanage severaI
slakehoIders - and in lhe vake of lhe
reguIalory response lo lhe hnanciaI
crisis, accounling and governance
slandards are changing exlreneIy
rapidIy. Reans of nev reguIalions/
slriclures are leing pulIished - and
ignorance is sinpIy nol an excuse
for lodays CIO. The CIO nusl
undersland, digesl and provide
proaclive feedlack vhere she disagrees,
and delale vilh reIevanl slakehoIders.
Ior inslance, is lhe currenl pro-cycIicaI
increase in prescriled lanking capilaI
reaIIy appropriale` Do sone parls
of proposed aseI III, such as CVA
for OTC derivalives, have severe
uninlended and conlra consequences
in lhe Indian conlexl (vhere every
lrade requires underIying cIienl
exposure), of acluaIIy penaIising risk
nanagenenl ly corporales`
So what should the
Trcasurcr/ CFO dn tnday?
If you are a CIO/ Treasurer, you
shouId prolalIy le Iooking al lhe
foIIoving:
a) As an exlreneIy crilicaI hrsl slep,
you shouId Iook lo undersland
vhal your nel hnanciaI risks
lo various narkel faclors are -
across assels and IialiIilies, across
cosls and revenues. Look for
naluraI risk offsels vilhin your
ovn hnanciaIs. An inporler, vho
exporls vaIue added produce viII
nosl IikeIy have a nel econonic
risk - even if reguIalors give her
lhe Iuxury of nanaging risks on
a gross lasis. Look for correIaled
risks - if you are deaIing in
connodilies for inslance (even if
lhey are liIIed in INR), lhere couId
67
Industry Insights
le an inpIicil exposure lo foreign
exchange. On lhe ip side, levare
of pilfaIIs of IogicaI correIalions -
nany exporlers in lhe pasl have
found lo lheir disnay lhal lheir
exporls acluaIIy dipped veII
leIov forecasl despile sharp
INR deprecialion, lecause gIolaI
grovlh and risk appelile had
dropped aIongside. Measure lhe
sensilivily of your nel hnanciaIs
lo noves in various narkels - a
lrue neasure of your risk.
l) Knov vhal looIs are avaiIalIe
lo nanage lhose nel risks - and
lhe cosls of using such looIs. In
lhe Indian IX conlexl, lhis vouId
incIude lracking IX spol/ forvard
(incIuding Iong lern forvards)/
fulures/ oplions/ currency and
inleresl rale svaps of various
kinds elc. And if you inlend lo
dynanicaIIy nanage your risks,
nake sure you independenlIy
undersland hov lhe pricing
vorks, and lhe polenliaI unvind
cosls.
c) e avare of vhal various direcl
and indirecl conpelilors are
doing, lo nanage lheir ovn risks.
Try and eslinale, lherefore, as lo
hov your alsoIule and reIalive
relurns vouId Iook Iike, under
various narkel scenarios.
d) Track narkels cIoseIy, and Iook
for Iov risk opporlunilies. e
avare lhal in narkels Iike India,
vhich are reIaliveIy iIIiquid
and do nol have capilaI accounl
converliliIily, you viII have
narkel disIocalions lhal offer
signihcanl opporlunilies lo
you. As an exanpIe, lhere have
leen silualions vhere a fuIIy
hedged LC, resuIls in raising
INR IialiIilies al a signihcanlIy
Iover cosl lhan vhere one couId
raise slraighl INR IialiIilies via
eilher INR Ioans or londs. On lhe
reverse side, ve have aIso seen
silualions, vhere an INR IialiIily
raised onshore, fuIIy svapped
inlo foreign currency, has
resuIled in nel foreign currency
IialiIilies al far cheaper rales
lhan vhal couId have leen raised
direclIy via LCs. Likevise,
given disIocalions in Indias
ralher shaIIov inleresl rale svap
narkels (IRS), il nay acluaIIy le
possilIe loday lo raise a oaling
rale Ioan, hedge vilh an INR IRS,
and arrive al a nel hxed rale lhal is
signihcanlIy Iover lhan a slraighl
hxed rale Ioan. And given lhe
iIIiquid nalure of our IX oplions
narkels, il nay le possilIe al
lines lo purchase insurance-
Iike payoffs al acceplalIy cheap
rales. These are langilIe and
dehnile vaIue-adds, every CIO
can and shouId provide lo her
organizalion.
e) esides laking advanlage of
lhese sonelines sulslanliaI
disIocalions, lhe CIO, in ny
hunlIe opinion, has no choice
lul lo forn a viev on underIying
narkels.
The hrsl slep lo forning a viev is
lo accepl ve viII le periodicaIIy
vrong. The second slep is lo sludy
and keep alreasl of fundanenlaI,
lechnicaI, narkel posilioning,
narkel ov, and reguIalory
faclors. Then forn, and conslanlIy
reviev your ovn lase case, shorl-
lern, nediun-lern and Iong lern
viev of narkels. Renenler, your
caII is yours, and yours aIone.
f) Consider lhe price al vhich you
couId cryslaIIize your exposures,
and conpare lhen vilh your
ovn vorId viev. If you are a nel
inporler, if your lase viev is of
sleep INR deprecialion, far nore
lhan lhal inpIied in lhe INR
forvards narkel, go ahead and
hedge aggressiveIy. If lhe cosl
of hedging exceeds lhe exlenl of
expecled deprecialion, go easy
on lhe hedges. Doing nolhing is
a perfeclIy vaIid slralegy, as Iong
as lhis is a conscious and veII
lhoughl oul choice.
g) Irrespeclive of your lase viev,
lhough, Iook for disasler and fal
laiI proleclion. Try and eslinale
vhal lhe lipping poinls are for
various narkel faclors, and le
on lhe conslanl Iookoul lo luy
insurance al an acceplalIe cosl.
h) Connunicale openIy and
conslanlIy vilh your slakehoIders.
e open lo chaIIenge. Lnsure you
have an independenl, honesl
reviev process lhal direclIy reporls
risks/ resuIls lo your nanagenenl
& olher slakehoIders. Ils okay lo
le shovn as vrong, lul never
okay lo Iose ones crediliIily/
le suspecled of leing Iess lhan
honesl. Cood governance viII
le lhe key dehning nanageriaI
allrilule in lhe fulure.
i) Never slop Iearning and
revieving. Markels are exlreneIy
conpIicaled, and forever evoIving
- fron an accounling, reguIalory,
lechnoIogy perspeclive. We
Managing market
risks has become a
critical imperative
of every corporate
treasury
68
Industry Insights
couId prolalIy never nasler aII
parls of il - lul lheres no harn
in lrying. Lncourage your lean
and slakehoIders lo conslanlIy
Iearn and disseninale as veII.
Irovide conslanl feedlack lo
aII slakehoIders - incIuding
reguIalors, poIicy nakers elc.
In Summary
To cul a Iong slory shorl, none of us
so-caIIed narkel experls can provide
any nagic vand lhal viII nanage
lhe CIOs consideralIe narkel risks.
The CIO is, sadIy, prelly nuch on her
ovn. Al lesl, ve can share vilh her
our ovn oulIook - and lhen Iel her
lake her ovn caII on her vorId viev
and lhe consequenl risk nanagenenl
slralegy. And sadIy, conpIele &
hoIislic 'hedging prolalIy does nol
exisl in lhe reaI vorId of lhe CIO.
In ny ovn personaI viev, I leIieve
lhal lhe underIying fundanenlaIs in
lhe US privale seclor are very slrong
- nolvilhslanding lhe poIilicaI and
hscaI ness lhere. elveen Iov Iand
prices, avaiIaliIily of Ialour, lhe
energing Norlh Anerican energy and
shaIe gas slory, and lhe Iarge anounl
of cash avaiIalIe vilh US corporales,
condilions are ripe for a resurgence of
grovlh and privale inveslnenl in lhe
US. This grovlh shouId heIp ease lhe
hscaI side of lhe piclure, in lhe Iong
run. And vhiIe nol as conpeIIing
as lhe US, parls of Lurope and
China are Iooking reIaliveIy slrong
loo - conpared lo lhe doonsday
piclures lhal vere painled earIier.
AII in aII, lhe exlernaI conlexl fron
Indias slandpoinl Iooks reasonalIy
favouralIe. A leller gIolaI grovlh
shouId keep lhe risk on senlinenl,
encourage capilaI ovs inlo India,
lesides giving a hIIip lo our exporls.
And inporlanlIy, lhe energing energy
suppIy slory pronises lo le a lrue and
genuine posilive for energy hungry
India in lhe nediun lern.
Our doneslic conlexl, hovever,
renains nurky. Our nuch needed
infraslruclure inveslnenls - in pover,
porls, naluraI resources, educalion,
freighl and inveslnenl corridors elc. -
renain norilund. Our nicroecononics
- vilness lhe high IeveIs of corporale
Ieverage and slressed lanking assels
- renains veak. There is a paIpalIe
lrusl and/ or governance dehcil aII
around. We renain vuIneralIe lo hscaI
Ied inalion, and lhe lvin dehcils. We
need lhings lo change. In lhe Iong
run, lhough, I renain luIIish on our
counlrys prospecls. The lrue slrenglh
of lhis counlry is, ils aInosl cIiched
denographic dividend - ve viII
afler aII, provide nuch of lhe vorIds
vorkforce in lhe fulure. And ve do
have lhe enlrepreneurs, lhe vork
elhics and lhe pronise of opporlunily
lo pass lhe ongoing lesls - evenluaIIy.
UnforlunaleIy, I couId veII le
conpIeleIy vrong in ny anaIysis - lul
I can assure lhal I vouId le praclising
vhal I preach.
Ananth Narayan G
Co-Head of Wholesale
Banking, South Asia.
Standard Charted Bank
Ananlh has 19 years of experience in lhe lanking induslry. He joined
Slandard Charlered ank in Augusl 2OO9. Irior lo Slandard Charlered ank
he vas vilh Cililank in Munlai liII 2OO5 (Direclor & Head of IICC Trading),
and vilh Deulsche ank in Munlai (Head of Rales SaIes & Trading, Soulh
Asia - liII Augusl 2OO9). As Co-Head of WhoIesaIe anking in SC, he
has joinl responsiliIily for lusiness slralegy, perfornance and peopIe for
WhoIesaIe ank across Soulh Asia. Ananlh is a direclor on lhe loard of
Iixed Incone Money Markel and DeaIers Associalion (IIMMDA), on lhe
loard of Slandard Charlered Securilies (India) Lld.. Ananlh has leen a parl
of various RI connillees (incIuding lhe one lhal Iaunched IX Oplions in
India, Inleresl Rale Iulures, IinanciaI SlaliIily elc). He appears in prinl and
leIevision nedia for vievs on hnanciaI narkels.
He hoIds a . Tech (LIeclricaI Lngg.) fron Indian Inslilule of TechnoIogy (IIT)
onlay and a MA fron Indian Inslilule of Managenenl (IIM) Lucknov.
69
Industry Insights
Introduction
The graduaI IileraIizalion of Indian
econony has resuIled in sulslanliaI
inov of foreign capilaI inlo India.
In India, lhe econonic IileraIizalion
in lhe earIy ninelies provided lhe
econonic ralionaIe for lhe inlroduclion
of Ioreign exchange (IX) derivalives.
The far-reaching changes in lhe Indian
econony since IileraIizalion in lhe
earIy 199Os have had a deep inpacl on
lhe Indian hnanciaI seclor. The various
sleps laken ly lhe Covernnenl since
IileraIizalion lo neel lhe chaIIenges
of a conpIex hnanciaI archileclure
have ensured lhal a nev face of lhe
Indian hnanciaI seclor is energing lo
cuIninale inlo a slrong, lransparenl
and resiIienl syslen.
The foIIoving deveIopnenls Ied lo
foreign capilaI inov inlo India.
Wilh Iiniled converliliIily on lhe -
lrade accounl leing inlroduced
in 1993, lhe environnenl lecane
even nore conducive for lhe
inlroduclion of lhese hedge
producls
In lhe year 1999, India ceased lo le -
a cIosed and prolecled econony
and adopled lhe gIolaIizalion
roule, lo lecone a parl of lhe
vorId econony
These sleps vere IargeIy
inslrunenlaI in lhe inlegralion of
lhe Indian hnanciaI narkels vilh lhe
gIolaI narkels. Wilh lhe disnanlIing of
lrade larriers, lusiness houses slarled
acliveIy approaching foreign narkels
Foreign Exchange Risk Management-
The way forward
Mr. Apoorv Srivastava,
Research Associale-IinanciaI Seclor, IICCI
In India, the economic
liberalization in the
early nineties provided
the economic rationale
for the introduction of
Foreign exchange (FX)
derivatives
70
Industry Insights
nol onIy vilh lheir producls lul aIso
lo source capilaI and direcl inveslnenl
opporlunilies. The deveIopnenl in
lhe Indian IX derivalives narkel
shouId le seen aIong vilh lhe sleps
laken lo graduaIIy reforn lhe Indian
hnanciaI narkels. Afler IileraIisalion
and currenl accounl converliliIily,
lhe vhoIe scenario changed. Risk
nanagenenl since lhen has under
gone a paradign shifl. The spurls in
foreign inveslnenls Ied lo sulslanliaI
increase in lhe quanlun of inovs and
oulovs in differenl currencies, vilh
varying nalurilies.
Foreign Exchange Risk: A
Historical Perspective
In India, lhere has leen an increasing
avareness for lhe need lo inlroduce
hnanciaI derivalives in order lo enalIe
hedging againsl narkel risks in a cosl
effeclive vay. A dynanic foreign
exchange narkel provides lusinesses
vilh a speclrun of hedging producls
for effecliveIy nanaging lheir foreign
exchange exposures. As Indian
lusinesses lecone nore gIolaI in lheir
approach coupIed vilh gIolaIizalion
of lrade and reIalive free novenenl
of hnanciaI assels, risk nanagenenl
lhrough a lroad lased aclive and Iiquid
foreign exchange narkel lecones
a necessily in India, Iike in olher
deveIoped and deveIoping counlries.
The nosl connon cause of foreign
exchange (IX) risk arises fron naking
overseas paynenls for inporls lhal
are priced in a foreign currency and
receiving foreign currency as paynenl
for exporls. IaiIing lo prolecl againsl
novenenls in IX rales effecliveIy
neans luying or seIIing vilhoul
having agreed lo a price in doIIars.
IX proleclion is an essenliaI service
for:
Inporlers and exporlers of goods -
and services
Ovners of overseas assels, joinl -
venlures or parlnerships
Croup conpanies and sulsidiaries -
in nore lhan one counlry
Corporale enlerprises have had lo
face lhe chaIIenges of lhe shifl fron Iov
risk lo high risk operalions invoIving
foreign exchange. Lxposure lo foreign
exchange risk arises fron:
Ioreign currency lorroving or -
deposils
Overseas sulsidiaries -
Assels Iocaled overseas -
The gIolaI narkel for hnanciaI
derivalives
1
has grovn sulslanliaIIy
in lhe recenl pasl. This lrenendous
grovlh in gIolaI derivalive narkels
can le allriluled lo a nunler of faclors.
They heIp lo prolecl lhe conpany fron
unanlicipaled evenls: adverse foreign-
exchange or inleresl-rale novenenls
and unexpecled increases in inpul
cosls, vhich is lhe risk lhal a change in
currency exchange rales viII adverseIy
inpacl lusiness resuIls.
Derivalives aIso aid in lhe
foIIoving:
They reaIIocale risk anong -
hnanciaI narkel parlicipanls
HeIp lo nake hnanciaI narkels -
nore conpIele
Irovide vaIualIe infornalion -
lo inveslors aloul econonic
fundanenlaIs
Irovide an inporlanl funclion of -
efhcienl price discovery
Make unlundIing of risk easier -
Need for a dynamic foreign
exchange market in India:
India Inc has reached lhe scaIe and
size of lhe gIolaI order and severaI
Indian organizalions are loday vorId
Ieaders in lheir respeclive induslries.
Arriving on lhe gIolaI scenario suljecls
corporalions lo diversihed revenue
slreans in various geographies, lhus
Ieading lo invoicing in gIolaI currencies
such as USD, CI and LUR anong
olhers. SiniIarIy, access lo various
lorroving nechanisns and dell
narkels has aIso Ied lo increased non-
INR exposure on looks. Il is inporlanl
lo nole lhal sone of Indian enlilies are
suljecl lo voIaliIily induced ly rupee
uclualions on lolh lheir I&L as veII
as aIance Sheel. ConpIicalions arise
fron lhe facl lhal conpelilion fron
olher geographies, vhiIe sharing
siniIar risk prohIe, is heIped ly
favouralIe exchange rale nechanisn
and induced cosl advanlages.
In lhe corporale hnance Iileralure,
research on risk nanagenenl has
focused on lhe inporlanl queslion of
vhy hrns shouId hedge a given risk.
________________________________________________________________________________________________________
1
A derivalive inslrunenl is connonIy dehned as one vhose price is derived fron an underIying quanlily lhal couId le an inleresl
or an exchange rale (in lhis case exchange rale) ve refer lo derivalives of noney and foreign exchange narkel prices as hnanciaI
derivalives.
71
Industry Insights
The Iileralure nakes lhe inporlanl
olservalion lhal neasuring risk
exposures is an essenliaI conponenl
of a hrns risk nanagenenl slralegy.
Wilhoul knovIedge of lhe prinilive
risk exposures of a hrn, il is nol
possilIe lo lesl vhelher hrns are
aIlering lheir exposures in a nanner
consislenl vilh lheory.
Issues in the Indian market:
The hislory of using hnanciaI
derivalives lo hedge foreign exchange
exposures ly corporalions in India
is fairIy recenl. LarIy 9Os vilnessed
fev foreign currency caII oplions
vrillen ly sone Indian corporalions.
Indian corporalions have hisloricaIIy
preferred slaying avay fron lhe
currency narkel as conpanies have
considered hedging as unvanled cosl
cenlers. Iirns preferred lo keep lheir
risk exposures un-hedged as lhey
found lhe forvard conlracls lo le very
coslIy.
Ieriods of exchange rale slaliIily
lred conpIacency. Inporlers vere
conhdenl lhal lhe Reserve ank of
India (RI) vouId inlervene lo haIl
any rupee decIine vhere as exporlers
vere of lhe viev lhal rupee has
aIvays leen over raled and lhal lhere
is no vay lhal il shaII appreciale fron
lhe presenl vaIue. This lradilionaI
nindsel aIso kepl conpanies avay
fron hedging lheir exposures. Due
lo lhe generic corporale reIuclance,
Iack of infornalion & lechnoIogy
and consideralion of hedging as
unvanled cosl cenlre, conpanies
invoIved in hedging have noslIy gone
lhe conservalive vay lo hedge lheir
exposures.
HisloricaIIy, oul of lhe Indian
conpanies engaging inlo hedging,
najorily have leen enlering inlo
forvard conlracls vilh lanks, vhich
have leen lhe Aulhorized DeaIers
(AD) in foreign exchange. The Iiniled
use and generaI Iack of inleresl in
lhe avaiIalIe inslrunenls can le
expIained ly lhe facl lhal dependence
on exlernaI sources of funding vas
Iiniled and lhe exlernaI seclor vasnl
reaIIy deveIoped.
If ve exanine lhe roIe of ISU lanks
in IX risk nanagenenl, ve olserve
lhal aIlhough India has vilnessed
inprovenenl in infornalionaI and
operalionaI efhciency of lhe foreign
exchange narkel, lhis has happened
al a haIling pace. LarIier, lhe Indian
conpanies had leen enlering inlo
forvard conlracls vilh lanks, vhich
vere lhe Aulhorised DeaIers (AD)
in foreign exchange. Today, lanks
lhal have leen pIaying lhe roIe of
faciIilalors are suffering fron acule
prolIens. IulIic seclor lanks, vhich
conlroI aInosl 75 of Indian forex
narkel, have leen grappIing vilh
issues such as under-slafhng and
lureaucralic pressures. Mosl of lhe
lanks in pulIic seclor lanks have
nol nerged lhe forex and noney
operalions vhich has lred inefhciency
in lheir vorking lhal has percoIaled lo
lhe corporale seclor as veII.
Impact of Global economy
and the India story
The gIolaI econony is in lhe nidsl
of a deep crisis and lhe cenlre of aclion
lhis line is lhe Luro Zone. The slory
of lhe sovereign dell crisis in lhe
peripheraI counlries of lhe Luro zone
region is gelling conpIex ly lhe day.
Lven as nenlers of lhe Luropean
Union agreed on a pIan lo address lhe
prolIens in Creece, IlaIy and olher
polenliaIIy hscaIIy slressed nalions,
lhe reaclion fron lhe narkels vas
nuled. This is indicalive of a severe
Iack of conhdence anongsl narkel
pIayers and is aIso reecled in lhe
difhcuIlies counlries Iike Spain, IlaIy
and nov even Irance are having in
accessing funds fron lhe narkel.
If ve lake lhe case of lanking seclor
in India, lhe governnenl as veII as lhe
RI have aplIy recognized lhe need
for lroadening Indian narkels and
have laken severaI sleps lo evoIve a
lruIy gIolaI currency, lhe Rupee. }usl
recenlIy lhe oulIook for lhe Indian
lanking seclor vas dovngraded
fron slalIe lo negalive ly Moodys.
WhiIe lhere are sone concerns,
lhey are nol grave enough lo have
varranled such a nove. The lanking
reguIalions in India are in Iine vilh
lhe inlernalionaI slandards and lhe
RI - Indias cenlraI lank - has had
a parlicuIarIy successfuI lrack record.
The capilaI adequacy ralios for a vasl
najorily of Indian lanks are alove
lhe prudenliaI norns and ve expecl
lhal as ve go ahead and enlrace lhe
aseI III norns, ve viII hnd ourseIves
on a hrner fooling. Ior nanaging lhe
Indian lanking syslen asluleIy and
for keeping il avay fron lhe hres
slarled foIIoving lhe Lehnan coIIapse
lhe RI has von accoIades across lhe
vorId. This is an area vhere olher
counlries can Iearn successfuI Iessons
72
Industry Insights
fron lhe Indian experience.
India is nov a veII-inlegraled vilh
lhe vorId econony and noves in
landen vilh gIolaI deveIopnenls,
lolh on lhe econonic fronl as veII
on lhe currency fronl. In India, lhe
hnanciaI econony direclIy inpacls lhe
reaI econony and any hnanciaI seclor
crisis vouId have ranihcalions far
leyond ilseIf. Indias hnanciaI seclor
has leen one of lhe faslesl groving
seclors in lhe econony. The econony
has vilnessed increased privale seclor
aclivily incIuding an expIosion of
foreign lanks, insurance conpanies,
nuluaI funds, venlure capilaI and
inveslnenl inslilulions. AIlhough
signihcanl sleps have leen laken in
reforning lhe hnanciaI services seclor,
sone areas require grealer focus.
One area of concern reIales lo 1.
lhe aliIily of lhe hnanciaI seclor
in ils presenl slruclure lo nake
avaiIalIe inveslilIe resources lo
lhe polenliaI inveslors in coning
years, such as equily, Iong lern
dell and nediun and shorl-
lern dell.
The olher najor conslrainl in 2.
lhe Indian scenario has leen
lhe inaliIily of lanks lo quickIy
enforce securily and access
lheir coIIaleraI, and lhe capilaI
conslrainls in recognizing Iarge
Ioan Iosses. Recenl neasures
laken ly lhe Covernnenl have
allenpled lo address lolh lhese
prolIens.
VoIaliIily in gIolaI connodily 3.
prices has had a najor inpacl
on Indian conpanies. This has
Ied lo non-perforning Ioans and
provisioning for credil Iosses
leconing a key area of concern
for lhe Indian hnanciaI syslen.
Way Forward:
Coing forvard, conpanies do
lake cognizance of lhe inporlance of
currency risk nanagenenl, hovever,
one is nol cerlain hov nany of lhe
conpanies are vorking lovards
luiIding capacily lo deaI vilh lhis
changing scenario. NeverlheIess,
nev hnanciaI derivalives have leen
aIIoved in lhe narkel lo provide for
exposures arising oul of increased
lusiness aclivily in lhe exlernaI seclor.
The heighlened voIaliIily and inaliIily
lo predicl rupee novenenls has Ied lo
severe pain on lhe parl of corporalions,
irrespeclive of vhelher lhey have
chosen lo hedge lheir foreign exchange
risks or nol.
In lhe recenl lines, lhere has leen an
increasing avareness of lhe need for
inlroduclion of hnanciaI derivalives
in order lo enalIe hedging againsl
narkel risk in a cosl effeclive vay. ul
nany hrns sliII prefer lo keep lheir
risk exposures un-hedged as lhey hnd
lhe forvard conlracls as cosl cenlres.
The prolIen in lhe Indian conlexl is
lhal lhe narkel for derivalives in India
olher lhan forvard conlracls is very
shaIIov.
In lhe currenl fornalive phase of lhe
deveIopnenl of lhe foreign exchange
narkel, as ve lake a cIoser Iook al
lhe inilialives laken ly corporale
enlerprises, il vouId le vorlhvhiIe lo
provide indicalive reconnendalions
on lhe vay forvard.
Recommendations:
The corporalions are -
reconnended lo Iook
slralegicaIIy inlo lheir exposure
and lake prudenl decisions in
hedging. This decision shouId
le lacked ly professionaI
lreasurers, an efhcienl lack
ofhce and good forecasling
lechniques.
Conpanies are aIso advised lo -
consider going in for various
olher derivalives lhal are exilIe
and cosl effeclive. In addilion
lo lhe lradilionaI physicaI
producls, such as spol and
forvard exchange rales, lhe
nev synlhelic or derivalive
producls, incIuding oplions,
fulures and svaps, and lheir use
ly lhe corporale seclor shouId
le considered prudenlIy. These
synlhelic producls have lheir
narkel vaIue delernined ly lhe
vaIue of a specihc, underIying,
physicaI producl.
The lanking seclor is recon- -
nended lo recruil speciaIized
personneI for lhe jol vilh Ialesl
The problem in the
Indian context is
that the market for
derivatives in India
other than forward
contracts is very
shallow
73
Industry Insights
lechnoIogy lo deaI in lhe nar-
kel. They shouId aIso nerge
lheir noney narkel and forex
operalion and lreal il as a sepa-
rale prohl cenlre for leller efh-
ciency.
The focus of nexl generalion -
reguIalion in doneslic
securilies narkel shouId
le on incIusive grovlh, i.e.
lroad lasing or deepening lhe
narkel vilh nore innovalive
producls and lechnoIogy for a
suslained grovlh lroughl oul
lhrough heaIlhy conpelilion.
Whalever palh lhe Lxchange
induslry lakes, il is necessary
lo keep il aIigned vilh pulIic
poIicy oljeclives, as exchanges
are lhe nechanisn lhrough
vhich narkel capilaIisn
survives.
These aII neasures viII dehnileIy
nake lhe IX narkel deep and vilranl,
vhich viII nake lhe vorking of
corporale seclor easier in deaIing vilh
lhe currency exposure.
References:
Selh, A.K 2OO8, InlernalionaI IinanciaI Managenenl Iage No- 3O1-347 1.
Cunnins, David }., IhiIIips, Richard D. and Snilh, Slephen D. : Derivalives and Corporale Risk Managenenl: 2.
Iarlicipalion and VoIune Decisions in lhe Insurance Induslry }ournaI of Risk & Insurance, VoI. 68, Issue 1, pp 51-
9O, March ( 2OO1)
}eevanandan, C., 2OOO, Ioreign Lxchange: Iraclices and ConlroI, SuIlan Chand and Sons, Nev DeIhi, India. 3.
Aple, I.C., 2OOO, InlernalionaI IinanciaI Managenenl, Tala McCrav hiIIs, Nev DeIhi, India. 4.
Sivakunar A and Sarkar R, Corporale Hedging for Ioreign Lxchange Risk in India 2OO8, Iage no. - 14-16. 5.
HenlscheI, L. and S.I. Kolhari: Are Corporalions Reducing or Taking Risks vilh Derivalives` Massachusells Inslilule 6.
of TechnoIogy Working Iaper }uIy (2OOO)
Apoorv Srivastava
Research Associate - Financial Sector
FICCI
Apoorv is Research Associale vilh IICCIs IinanciaI Seclor Division
and lhe Ldilor of lhe quarlerIy pulIicalion, IinanciaI Ioresighls.
He hoIds an MSc in usiness (AnaIysis) & Iinance fron Universily
of Leicesler, UK and an Honors in Lcononics fron Universily
of DeIhi.
Disclaimer: Views are personal and not of the organization.
The Policy Pulse
76
The Policy Pulse
MId Quartcr Mnnctary Pn!Icy RcvIcw 2012 - 18th
December, 2012
The RI Iefl lhe key poIicy rales unchanged in
ils Mid Quarler Monelary IoIicy Reviev 2O12. The
Cash Reserve Ralio (CRR) slood al 4.25 and repo
rale under lhe Liquidily Adjuslnenl IaciIily (LAI)
slood al 8. ConsequenlIy reverse repo rale under
lhe Liquidily Adjuslnenl IaciIily (LAI) renained
unchanged al 7.
Hovever, RI had cul lhe Cash Reserve Ralio
(CRR) ly 25 lasis poinls fron 4.5 lo 4.25 in
second Quarler Reviev of Monelary IoIicy heId on
3Olh Ocloler, 2O12. This nove ly RI injecled around
$175 liIIion of prinary Iiquidily inlo lhe lanking
syslen.
Il is expecled lhal lhe RI viII slarl culling rales
onIy fron }anuary - }uIy 2O13, once inalion eases.
Inalion as neasured ly aII indices has renained
eIevaled and vhoIesaIe price index-lased inalion
has renained alove RIs conforl zone of 5-5.5 per
cenl for nearIy lhree years nov.
RBI plans to push Export Lending
The RI has nooled a separale carve - oul for exporl
credil vilhin lhe overaII priorily seclor Iending largel
for lanks lo nake funds avaiIalIe for exporls anidsl
rising concern lhal decIining exporls viII keep currenl
accounl dehcil eIevaled and depreciale lhe rupee,
undernining ils efforls lo rein in inalion.
Indias exporls feII for sevenlh nonlh running,
decIining 4.2 in Novenler lo $22.9 liIIion vhiIe
inporls rose 6.4 lo $41.5 liIIion, yieIding a lrade
dehcil on $19.3 liIIion, jusl shorl of record high $21
liIIion.
Companies in Agri Business now in Priority
Sector
The RI has revised lhe dehnilion of priorily sec-
lor lo incIude corporale engaged in agricuIlure and
aIIied aclivilies, and anended lhe Iinils for cerlain
calegories. RI has cIarihed lhal Ioans lo corporale,
incIuding conpanies forned ly individuaI farn-
ers, parlnership hrns and co-operalives of farners
direclIy engaged in agricuIlure and aIIied aclivi-
lies, viII nov le considered as priorily seclor Iend-
ing. Hovever, lhe cenlraI lank has capped such
Iending al Rs 2 crore. Il said onIy crop Ioans and
Iending lo pre-harvesl and posl-harvesl aclivilies
and exporl credil viII cone under priorily seclor
Iending. AIIied aclivilies viII incIude dairy, hsh-
ery, aninaI huslandry, pouIlry, lee-keeping and
sericuIlure.
The RI has aIso raised lhe priorily seclor Iending
Iinil for nediun and snaII enlerprises in lhe service
seclor lo Rs 2 crore fron Rs 1 crore. Il has aIso anended
norns for housing Ioans under priorily seclor. ank
Ioans lo any governnenl lody for conslruclion of
hones or for sIun cIearances and rehaliIilalion of
sIun dveIIers viII aIso le incIuded in lhe priorily
seclor suljecl lo a ceiIing of Rs 1O Iakh per dveIIing
unil.
The per unil housing cosl Iinil for housing projecls
for conslruclion of hones excIusiveIy for veaker
seclion has leen raised fron Rs 5 Iakh lo Rs 1O Iakh
per unil.
RBI plans to roll out gold linked products
The RI has proposed lhe inlroduclion of goId
- Iinked producls lo pronole lhe use of goId as a
hnanciaI assel in a vay lhal viII reduce lhe pressure
on goId inporls and nanage lhe counlrys olsession
vilh goId inveslnenl.
RI couId consider nodihed goId deposil schenes,
goId Iinked accounls, goId accunuIalion pIans and
goId pension pIans.
Gold deposit schemes - Inveslors can hoId goId
deposils vilh lanks for a dehnile period of line.
Gold - linked accounts - They vouId le non
inleresl learing accounls, giving users lhe exposure
lo goId narkels - vhere lhe goId vouId le purchased
and hedged alroad.
Gold accumulation plans - To le in lhe forn of
SIIs vhere snaII quanlilies couId le loughl al
reguIar inlervaIs.
Banking Sector
77
The Policy Pulse
Gold Pension Plan - Ils largeled al senior cilizens
and aIIovs reverse norlgage of properlies. anks viII
open an annuily pIan vilh lhe insurance conpanies
for a dehnile period.
Figures on Gold Imports
CoId inporls 2O11 2O12
Q1 228
Q2 153
Q3 2O5 223
Q4 157
RBI bans bank loans to buy gold in any form
The RI has nolihed a lolaI lan on lanks fron
advancing any Ioans lo cusloners for purchasing
goId in any forn, vhich incIudes prinary goId, goId
luIIion, goId jeveIIery, goId coins, unils of goId
Lxchange Traded Iunds (LTI) and unils of goId
nuluaI funds, lo dissuade peopIe fron induIging in
specuIalive aclivily.
No advances shouId le granled ly lanks againsl
goId luIIion lo deaIers or lraders in goId if, in lheir
assessnenl, such advances are IikeIy lo le uliIised for
purposes of hnancing goId purchase al auclions or
specuIalive hoIding of slocks and luIIion.
Hovever, RI said lhal lanks are aIIoved lo give
Ioans for 'genuine vorking capilaI requirenenls lo
jeveIIers The decision vas laken in viev of signihcanl
rise in inporls of goId in recenl years, The slep ly
lhe RI, cane on concerns lhal direcl lank hnancing
for lhe purchase of goId in any forn lhal is luIIion,
prinary goId, jeveIIery, goId coin, elc couId Iead lo
fueIIing of denand for goId in lhe counlry and viII
pul pressure on currenl accounl dehcil.
Gnvcrnmcnt, RBI fnr 0cxIbI!Ity In va!uatInn
nnrms nf un!Istcd IndIan rms
The Covernnenl and lhe RI are considering
reIaxalion in lhe sliff vaIualion norns governing
foreign direcl inveslnenl in unIisled Indian hrns, a
nove lhal couId polenliaI loosl privale equily ovs.
The proposaI is anong neasures leing considered lo
loosl capilaI ovs lo fund Indias yavning currenl
accounl dehcil lhal is veakening lhe currency.
RBI to simplify KYC norms
The RI viII soon cone up vilh guideIines
lo sinpIify knov-your-cusloner (KYC) norns
and lo nake Aadhaar lhe proof for address and
idenlihcalion. There are aIso lhoughls on coning
up vilh poIicy neasures on lhe InlernalionaI ank
Accounl Nunler, vhich viII faciIilale porlaliIily.
RI is aIso lrying lo narry lanks and posl ofhces in
an eIeclronic fund nanagenenl syslen. RI is aIso
slressing on lhe neans ly vhich lhe paynenl syslen
couId vork as a calaIysl for hnanciaI incIusion. India
is lhe second Iargesl in lerns of cash usage lo gross
doneslic producl. Therefore, efforls vere leing
nade lo nake India a Iess-cash sociely. Innovalive
paynenl syslens can handIe Iarge accounl
lransaclions. There is aIso a need for poinl-of-saIe
infraslruclure and lanks shouId go in a lig vay for
ils acquisilion. There is aIso a need lo creale easy-lo-
use producls and easiIy avaiIalIe producls.
RBI trying to mesh current liquidity, Basel-III
norms
The RI is vorking on a vay lo incIude Iiquidily
heId ly lanks under lhe currenl nandale lo gel
eIigiliIily under lhe aseI-III regine as veII. This
nighl invoIve lringing dovn lhe requirenenl of
addilionaI Iiquidily lhal lanks need lo provide as
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78
lhe nev norns sel in. The sel of ruIes under aseI-III
prescriles lanks lo luiId a Iiquidily coverage ralio.
Hovever, lanks in India are nandaled lo nainlain
lhe nininun Iiquidily al 23 per cenl of nel denand
and line IialiIilies as lhe Slalulory Liquidily Ralio
(SLR) under RI norns.
RI is lherefore vorking oul a schene under
vhich parl of SLR is lrealed as lhe aseI-III Iiquidily
requirenenl. Ior Indian lanks, RI has Iaid dovn
phases in order lo conpIy vilh lhe aseI-III norns
vilhin lhe lransilion period of }anuary 2O15-}anuary
2O18. According lo RI, CapilaI requirenenls
viII increase and nighl have an inpacl on lanks
prohlaliIily. Therefore, lhere is a need lo raise capilaI
even if lhe aseI-III norns vere nol in pIace.
RBI to set aside funds for buying illiquid gilts
The RI is vorking vilh lhe governnenl lo sel
aside funds for luying iIIiquid giIls fron lhe narkel.
Over a period of line RI viII have sone ludgel
vhere ve viII lry lo repair sone of lhose securilies in
vhich voIunes are Iov, and creale voIunes for lhose
securilies vhich have higher voIunes. According
lo Mr. H R Khan, Depuly Covernor, RI, lhere is a
joinl group lelveen lhe RI and lhe governnenl
vhere lhis has leen discussed under cash and dell
nanagenenl. ul il is difhcuIl lo say if innedialeIy
lhey viII le in a posilion lo do so.
Lxperls say lhis nove shouId cone in vhen
Iiquidily lighlens in lhe syslen. In a scenario of lighl
Iiquidily, lhe RI can announce lhis. If lhis happens,
il viII punp in Iiquidily inlo lhe syslen, and giIl
yieIds viII aIso faII. This nove viII aIso heIp lanks
lo gel rid of iIIiquid securilies. anks hoId a Iol of
iIIiquid securilies. The difference lelveen lhe yieId
of Iiquid and iIIiquid securilies of sane nalurily
lenure is aloul 1O-15 lasis poinls. If lhese iIIiquid
securilies are loughl ly lhe RI, lhe yieId curve viII
gel reaIigned.
RBI aIms tn dcvc!np mnrc cfcIcnt, Intcgratcd
payment system
The Reserve ank ains lo deveIop a nore efhcienl
and inlegraled paynenl syslen in lhe counlry.
In ils 'Iaynenl Syslens In India: Vision 2O12-15
docunenl, RI said lhe nain focus is lo provide
a nodern eIeclronic paynenls syslen lhal is safe,
sinpIe and Iov-cosl for use ly aII. The paynenl
syslen inilialives laken over 2OO9-2O12 have resuIled
in deeper acceplance and penelralion of nodern
eIeclronic paynenl syslen. Though cheque is sliII a
doninanl node of paynenl, ils share has cone dovn
fron 65 lo 52 in voIune lerns and fron 12 lo
9 in vaIue lerns.
Iaynenls in non-cash paynenls have shovn an
upvard lrend vilh eIeclronic paynenls ly lhe end of
2O11-12, consliluling 91 in lerns of vaIue (fron 88
in 2OO9-1O) and 48 in lerns of voIune (fron 35 in
2OO9-1O).Nolvilhslanding lhese acconpIishnenls,
cash renains lhe predoninanl paynenl node in
lhe counlry. The vaIue of lanknoles and coins in
circuIalion as a percenlage of CDI (12.O4) is very
high in lhe counlry vhen conpared lo olher energing
narkels, Iike raziI, Mexico and Russia, according
lo RI.
Likevise, non-cash lransaclions per cilizen are
very Iov in India (six lransaclions per inhalilanl)
vhen conpared vilh olher energing narkels.
The eIeclronic paynenl producls and services is
concenlraled lo a Iarge exlenl in lhe lier-I and lier-II
areas and noslIy lo peopIe having access lo fornaI
lanking channeIs.
Hovever, lhe seclion of unlanked and under-
lanked popuIalion in lhe counlry have nissed
lhe landvagon of nodern eIeclronic paynenls
syslen.The use of eIeclronic paynenl inslrunenls
aIIovs lhe unlanked lo slarl luiIding a lransaclion
hislory, vhich can le a slep lovards inilialing lhen
lovards hnanciaI incIusion. The nodern eIeclronic
paynenl syslens viII aIso neel lhe paynenl needs
such as renillances under lhe overaII anlil of
hnanciaI incIusion.
The Policy Pulse
79
SEBI allows Mutual Funds to take part in credit
default swaps market
In a nole issued on Novenler 15, 2O12, SLI has
pernilled nuluaI funds lo parlicipale in credil defauIl
svaps (CDS) narkel, as per lhe guideIines issued ly
RI. This foIIovs lhe RI nolihcalion issued in May
2O11 slaling lhe guideIines on CDS for corporale
londs. In a svap agreenenl, lhe seIIer of lhe CDS
conpensales lhe luyer in lhe evenl of a Ioan defauIl.
SLI has aIIoved nuluaI funds lo parlicipale in CDS
lransaclions onIy as users (proleclion luyer). Thus,
nuluaI funds are pernilled lo luy credil proleclion
onIy lo hedge lheir credil risk on corporale londs lhey
hoId. They shaII nol le aIIoved lo seII proleclion and
hence are nol pernilled lo enler inlo shorl posilions in
lhe CDS conlracls. Hovever, lhey shaII le pernilled
lo exil lheir loughl CDS posilions.
SEBI relaxes MF exposure for Housing Finance
companies
Iroviding nore Ieevay for housing hnance
conpanies (HICs), SLI has reIaxed lhe inveslnenl
Iinil for such enlilies in dell nuluaI funds. In Iighl of
lhe inporlanl roIe pIayed ly lhe HICs in lhe housing
seclor, il has leen decided lhal an addilionaI exposure
nol exceeding 1O per cenl of nel assels of lhe schene
shaII le aIIoved onIy lo HICs as parl of hnanciaI
services seclor for prudenliaI Iinils in dell orienled
schenes. The lolaI inveslnenl in HICs shaII nol
exceed 3O per cenl of lhe nel assels of lhe schene.
SEBI allows trading of ETFs in SLB segment
SLI has nade 'Iiquid Index Lxchange Traded
Iunds (LTIs) eIigilIe for lrading in lhe Securilies
Lending and orroving (SL) segnenl. LarIier, SLI
had aIIoved onIy securilies lraded in lhe Iulures &
Oplions (I&O) segnenl for Iending and lorroving
of securilies. Wilh lhe inlroduclion of lhe LTIs in
lhe SL segnenl, lhere vouId le vider parlicipalion
as veII as increased voIunes. LTI shaII le deened
'Iiquid provided lhe Index LTI has lraded on al Ieasl
8O per cenl of lhe days over lhe pasl six nonlhs and
ils inpacl cosl over lhe pasl six nonlhs is Iess lhan or
Capital Markets Sector
equaI lo 1 per cenl.
SEBI seeks more powers to deal with defaulters
SLI has proposed lhal lhe SLI Acl le anended
lo provide for effeclive nechanisns for recovery
of nonelary penaIlies fron defauIlers in such a
nanner as nay le specihed ly reguIalions or if
found expedienl as per provisions of lhe Incone Tax
Acl lhrough a reference lo lhe incone lax aulhorily
on lhe Iines of lhe provisions of Seclion 39 of lhe
Conpelilion Acl, 2OO2.
SEBI comes out with norms for RGESS and asks
stock exchanges to furnish list of eligible stocks for
RGESS
The Rajiv Candhi Lquily Savings Schene (RCLSS)
vas nolihed ly lhe Deparlnenl of Revenue, Minislry
of Iinance on Novenler 23, 2O12. SLI has asked
slock exchanges lo provide a Iisl of eIigilIe slocks
for lhe RCLSS. Slock exchanges viII have lo aIso
furnish a Iisl of eIigilIe exchange lraded funds and
nuluaI fund schenes on lheir velsiles. Iund houses
viII have lo cone oul vilh speciaI pIans under Rajiv
Candhi Lquily Savings Schene (vhich vas iniliaIIy
reslricled lo direcl slock inveslnenls).
Government asks States to act against illegal
share trading
The Covernnenl has advised Slales and Union
Terrilories lo lake urgenl sleps lo lackIe iIIegaI
lrading of shares. SLI has received conpIainls
againsl sone enlilies aIIeging iIIegaI lrading of shares
The Policy Pulse
80
in various parls of lhe counlry. SLI on ils parl has
inilialed lraining progrannes and guidance lo Slale
IoIice Deparlnenls lo deaI vilh inslances of iIIegaI
lrading.
SEBI Committee to review depository system
SLI is Iooking lo overhauI ils norns for deposilory
syslens vilh an ain lo slrenglhen ils oversighl
nechanisn and lo safeguard againsl any syslenic
risks posed ly singIe-poinl faiIures. A 'Deposilory
Syslen Reviev Connillee consliluled ly SLI
has leen asked lo conducl an overaII assessnenl/
adequacy of exisling deposilory franevork and
idenlify polenliaI areas for reviev. The nove cones
al a line vhen efforls are on lo expand lhe anlil
of deposilories ly aIIoving lhen lo hoId nev assel
cIasses in denal fornal.
Government may cut withholding tax on FII debt
AII III dell inveslnenls are suljecl lo a vilhhoIding
lax deduclion on coupons. The lax, vhich varies
lelveen 2O.6 per cenl lo 21.O12 per cenl depending
on lhe nalure and nel laxalIe incone of lhe III,
nakes inveslnenls in Indian londs unecononicaI. Il
is leIieved lhal if lhe cosl of hedging exchange risk
is aIso faclored in, lhen relurns fron lhe lond drops
lo unacceplalIy Iov IeveIs. The Iinance Minislry is
considering a proposaI ly IIIs lo lring dovn lhe
rales of vilhhoIding lax on Iong-lern governnenl
dell inslrunenls. The proposaI vas discussed in a
neeling lelveen Iinance Minislry, SLI, lop IIIs
and inlernediaries.
SEBI discontinues mini derivatives contracts on
bourses
SLI said il has decided lo disconlinue nini
derivalives conlracls on Sensex and Nifly indices, lo
discourage snaII inveslors fron gelling allracled lo
lhis segnenl. The Ialesl nove revises SLIs decision
in Decenler 2OO7 lhal aIIoved nini derivalive
conlracls. Such conlracls ~ having a nininun size
of Rs 1 Iakh ~ vere aIIoved on Ieading indices,
Sensex and Nifly. No fresh nini derivalives conlracls
shaII le issued.
SEBI allowed 12 more Alternative Investment
Funds in October and November 2012
SLI aIIoved 12 enlilies lo sel up AIlernalive
Inveslnenl Iunds (AIIs), a nevIy crealed cIass of
pooIed-in inveslnenl vehicIes for reaI eslale, privale
equily and hedge funds, in lhe nonlhs of Ocloler and
Novenler 2O12. SLI in lhe Iasl fev years has aIready
aIIoved nine AIIs lo sel up shop in lhe counlry.
SEBI raises minimum capital requirement for
brokers
SLI has revised lhe lase nininun capilaI (MC)
deposil requirenenl for lrokers (offering aIgorilhnic
lrading) lo a naxinun of Rs 5O Iakhs. MC is lhe
deposil given ly lhe nenler of lhe exchange againsl
vhich no exposure for lrades is aIIoved. Slock lrokers
and lrading nenlers vilh nalion-vide presence
doing proprielary lrading (vilhoul aIgorilhns) viII
have lo lring in a MC of Rs 1O Iakh. Those vho
lrade onIy on lehaIf of cIienls (vilhoul aIgorilhns)
have lo lring in Rs 15 Iakh. Ior lhose doing prop and
cIienl lransaclions (vilhoul aIgorilhns), lhe MC is
Rs 25 Iakh. Ior lrokers/lrading nenlers nol having
nalionvide presence lhe MC requirenenl vouId le
4O per cenl of lhe alove.
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The Policy Pulse
81
The revision is lased on lhe risk lhal lrokers are
exposed lo, as a resuIl of luying and seIIing slocks on
lheir ovn lehaIf (proprielary lrading) and on lehaIf
of lheir cIienls. This appIies lo lolh aIgorilhnic
and non-aIgorilhnic lrades. Lxchanges have lo
inpIenenl lhe circuIar ly March 31, 2O13.
SEBI takes measures to beef-up retail investor
safety
NearIy lvo nonlhs afler reIeasing a drafl paper on
a safely nel ne chanisn, indicalions are lhal SLI is
Ieaning lovards increasing safely for relaiI inveslors.
SLIs drafl proposaI seeks lo shieId any IIO inveslor
vho invesls up lo Rs 5O,OOO and caps lhe safely nel
al 5 percenl of lhe issue proceeds. Lxchanges have
voled supporling lhe proposaI, especiaIIy given lhe
huge variance in infornalion avaiIalIe aloul various
issues, vhich affecls pricing. SLI leIieves lhal if
lhere vas good pricing and lhe discIosures vere
correcl and veII Iaid oul, issues vouId le successfuI.
Companies Act gives SEBI a leg-up
According lo lhe nev provisions of lhe Conpanies
iII, 2O12, if a conpany, Iisled or unIisled, nakes
an offer lo aIIol or inviles sulscriplion, or aIIols, or
enlers inlo an agreenenl lo aIIol, securilies lo 5O or
such higher nunler as nay le prescriled, lhe sane
shaII le deened lo le an offer lo lhe pulIic and
shaII accordingIy le governed ly lhe provisions
provided in lhis regard ly SLI. Though lhe earIier
IegaI posilion of lhe Iav on issues of securilies nade
lo over 5O persons vas heId lo le lhe sane, lhere vas
no express provision lhal covered lhe differences
lelveen a privale pIacenenl and a pulIic offer.
DIsc!nsc data tn cxchangcs rst: 5EBI tn IndIa
Inc.
SLI asked Iisled conpanies lo discIose lheir
nonlhIy saIes, lurnover and produclion hgures lo
slock exchanges, lefore sharing lhese vilh lrade
lodies and induslry associalions. SLI leIieves such
dala, vhich have a learing on slock prices, shouId
hrsl le disseninaled lo slock exchanges lo ensure aII
inveslors have uniforn access lo lhese.
SEBI seeks approval for foreign funds in
alternative investment funds
In May 2O12, SLI had nolihed lhe guideIines for
AIIs, a nev cIass of narkel inlernediaries lhal are
essenliaIIy funds eslalIished or incorporaled in India
for lhe purpose of pooIing in capilaI fron Indian
and foreign inveslors for furlher inveslnenls. SLI
has nov asked lhe governnenl lo aIIov foreign
inveslnenls inlo aIlernalive inveslnenl funds and
aIso loosl dovnslrean inveslnenls ly offshore
enlilies under lhe foreign direcl inveslnenl poIicy
franevork. SLI has aIso aIIoved pronolers of Iisled
conpanies lo ofoad up lo 1O of equily lo regislered
AIIs lo allain nininun 25 pulIic hoIding.
SEBI eases debt allocation mechanism for FIIs
In Novenler 2O12, SLI had aIIoved IIIs lo re-invesl
5O per cenl of lheir dell hoIdings fron lhe previous
caIendar year lo lhe succeeding caIendar year vilh
effecl fron }anuary 1, 2O14. In a parl-nodihcalion
of lhis circuIar, SLI has nov aIIoved cerlain IIIs lo
re-invesl up lo 5O per cenl of lheir naxinun dell
hoIdings al any poinl of line in 2O13 ilseIf.
SEBI to revise rules on insider trading; to
synchronize norms with the guidelines of
Companies Bill
SLI pIans lo revise lhe ruIes on insider lrading and
fronl-running, lo synchronize lhe ruIes vilh lhose
sel dovn ly lhe governnenl in lhe Conpanies iII,
vhich vas approved ly lhe Lok Salha in Decenler
2O12.
SEBI mulls norms for trading permitted stocks on
exchanges
Lvery conpany, vhich is Iisling on lhe slock
exchange, is required lo sign a Iisling agreenenl
vilh eilher one or vilh lolh lhe slock exchanges.
The Policy Pulse
82
Standard insurance product for rural and social
sector: IRDA
The IRDA reIeased drafl guideIines for a conposile
package of slandard insurance producl for ruraI and
sociaI seclor.
In order lo pronole and deveIop insurance
avareness in lhe ruraI areas, provide proleclion lo
various risks and lo enalIe lhen lo luiId a corpus
for lheir fulure needs, IRDA is keen lo Iaunch a
conprehensive slandard producl conlining lolh
Iife and non-Iife covers. Ior lhis lhe reguIalor has
reIeased sone drafl guideIines and inviled feedlack
fron insurance conpanies, inlernediaries and olher
nenlers fron lhe insurance induslry.
Finance Minister announced incentives to
promote life insurance
To revive lhe Iife insurance seclor in India, lhe
IM announced a fev incenlives lo loosl grovlh.
Incenlives proposed couId le in lhe forn of lringing
ease in inveslnenl norns for insurance conpanies,
enpovering lanks lo seII producls of nuIlipIe
insurance conpanies and expedile lhe process for
cIearing nev producls. Chidanlaran had asked
Deparlnenl of Revenue and CDT/CLC lo conpIele
lhe exaninalion of suggeslions ly Ocloler 1O, 2O12 so
lhal appropriale decisions nay le announced soon.
IRDA prcscrIbcs tImc !ImIts fnr !Ing Rcfcrra!
applications
Oc|c|cr 2012
Afler lhe IRDA roIIed oul lhe Sharing of Dalalase
ReguIalions, 2O1O, aII insurance conpanies have leen
Insurance Sector
The Securilies Conlracls (ReguIalion) Acl (SCRA) has
a provision lhal any conpany, vhich has a Iisling
agreenenl vilh a recognized slock exchange, can
le lraded in any of lhe recognized slock exchanges.
SLI is nov nuIIing sone guideIines for lhis purpose
lecause lhere are no such guideIines avaiIalIe excepl
for lhe SCRA provisions, vhich aIIov such lrading
lo happen and aIso lecause a lhird exchange vouId
nov cone in.
SEBIs unveils share buyback proposals
The SLI unveiIed a series of proposaIs incIuding
one lhal says conpanies nusl purchase al Ieasl 5O
percenl of lhe announced luylack offer fron lhe
currenl nininun of 25 percenl. SLI aIso proposed
lhal lhe process le conpIeled vilhin lhree nonlhs
of lhe announcenenl of lhe offer fron lhe currenl
one year, and suggesled conpanies le larred fron
raising capilaI for lvo years afler purchasing ils ovn
shares. These neasures are neanl lo crack dovn on
polenliaI aluses as sone conpanies have announced
luylacks lul did nol acluaIIy end up doing so,
lenehlling nonelheIess fron lhe ensuing gains in
lheir share price.
Government asks SEBI to remove cool-off period
in OFS
The CenlraI Covernnenl has soughl a reIaxalion
fron SLI on lhe nandaled 12-veek cooIing-off
period afler any diveslnenl lhrough lhe nevIy-
inlroduced offer for saIe (OIS) roule. In lhe currenl
SLI reguIalions, a pronoler offering shares lhrough
an OIS is reslricled fron saIe or purchase of shares
for 12 veeks. During lhis period, lhey nay seII furlher
shares onIy lhrough anolher OIS, vilh a gap of lvo
veeks. ReIaxalion of lhe 12-veek cooIing off period
viII aIIov conpanies such as NTIC and SAIL, in
vhich lhe governnenl has proposed lo divesl slakes,
lo aIIol shares lo eIigilIe enpIoyees innedialeIy
afler lhe share-saIe.
The Policy Pulse
83
hIing appIicalions for approvaI of referraI enlilies
vilh IRDA. This process is done lhrough ReferraI
IorlaI designed ly IRDA.
ul a recenl reviev done ly lhe IRDA lroughl sone
issues lo lhe fore vhich is naking il difhcuIl for lhe
IRDA lo knov hov nany agreenenls are acluaIIy in
effecl. If lhe line frane exceeds a cerlain period and
faIIs in lhe nexl hnanciaI year, aII such appIicalions
i.e., pending/approved need lo le evaIualed afresh
ly lhe reguIalor.
In order lo avoid lhis, IRDA has decided lo prescrile
line Iinils for each of lhe foIIoving cases:
Insurers are required lo resulnil lhe pending -
appIicalions afler sulnilling lheir renarks/
responses for lhe queries/requirenenls raised
ly IRDA vilhin lhree (3) nonlhs fron lhe dale
of queries/requirenenls and
Insurers are required lo execule referraI -
agreenenls vilh lhe approved enlilies vilhin
lhree (3) nonlhs fron lhe dale of approvaI ly
IRDA
AII lhe insurance conpanies have lo conpIy vilh
lhe alove line Iinils. In case any of lhe insurance
conpanies faiI lo do so, lhen lhe appIicalions viII le
deened lo le Wilhdravn ly lhe Insurers.
IRDA gears up to deliver better and faster product
decisions
Nctcm|cr 2012
Ior a Iong line nov, lhe insurance conpanies have
leen conpIaining lhal lhe process of any guideIine
fornalion ly lhe IRDA is very sIov. They leIieve lhal
lhe deIayed process affecls lheir produclivily and
increases daiIy hassIes and operalionaI difhcuIlies.
Hovever, lhe nev slep laken ly IRDA lo vork in
sync vilh lhe Life Insurance CounciI of selling up
producl-specihc connillees viII indeed expedile lhe
enlire process and ease oul lhe sharp edges.
The producl specihc connillee vouId in facl,
cover Unil Linked Insurance IIans (ULIIs) as veII as
lradilionaI pIans.
Insurers eye tier II and tier III cities to evaluate
new business statistics
Nctcm|cr 2012
India is fasl energing on lhe vorId nap as a slrong
econony and a gIolaI pover. The counlry is going
lhrough a phase of rapid deveIopnenl and grovlh.
Wilh a huge popuIalion and Iarge unlapped narkel,
insurance happens lo le a lig opporlunily in India.
According lo sources Iarge segnenl of ruraI India
is sliII unlouched lecause of Iong dislances, poor
dislrilulion and high relurn cosls.
Premium collection drops for life insurance
companies
Nctcm|cr 2012
According lo a reporl shared ly IRDA, preniun
coIIeclion of lhe Life Insurance Conpanies feII ly 3.45
per cenl during lhe hrsl seven nonlhs of lhe hnanciaI
year 2O12-13. This faII is allriluled ly various faclors
such as Iack of innovalive producls, voIaliIe equily
narkel and various olher faclors lhal are affecling
hnanciaI seclors.
Insurance Firms being investigated for suspected
nonpayment of Service Tax
Dcccm|cr 2012
Iinance Minisler said in Lok Salha lhal sone
Insurance Conpanies have leen suspecled lo have
evaded service lax and invesligalion for lhe sane
has leen done. He aIso nenlioned lhal in sone cases
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The Policy Pulse
84
lhe anounl due has aIready leen recovered as veII.
He added lhal in cases vhere invesligalions are
conpIeled, cases have leen adjudicaled and service
lax IialiIily conhrned, denand nolice has leen
issued.
Motor Insurance Policy Tenure may rise to 2 Years
soon: IRDA
Dcccm|cr 19, 2012
The IRDA is conlenpIaling lo provide for nolor
insurance poIicies having lvo years lerns for lolh
connerciaI and privale vehicIes. This viII reduce lheir
renevaI hassIes. Al lhe sane line il viII augnenl lhe
incone lhrough preniuns for insurance providers.
Cabinet defers decision on Insurance and Pension
reforms bill
Dcccm|cr 2012
Covernnenl has poslponed ils decision lo presenl
lvo liIIs perlaining lo insurance and pension seclor
lo lhe nexl session of parIianenl, lherely deIaying lhe
Reforms Tracker: A Review of the Winter Session
of Parliament and Bills Passed
The Winler Session, 2O12 of IarIianenl vhich
connenced on Thursday, lhe 22nd of Novenler,
2O12, concIuded on Thursday, lhe 2Olh of Decenler,
2O12. The Session provided 2O sillings spread over a
period of 29 days. As nany as seven liIIs vere passed
ly lhe Indian IarIianenl al lhe end of lhe Winler
Session vhich slarled on Nov 22.
One of lhe inporlanl fealures of lhe Winler Session
vas lhal severaI liIIs incIuding IDI and nallers
reIaled lo ILMA, Conslilulion Anendnenl iIIs elc.
couId le sleered lhrough division of vole, exhililing
Covernnenls resoIuleness and leller preparedness.
During lhe Session, 9 iIIs (7 in lhe Lok Salha
and 2 in lhe Rajya Salha) vere inlroduced. The Lok
Salha passed 7 iIIs and lhe Rajya Salha passed 8
iIIs during lhe session. TolaI nunler of iIIs passed
ly lolh Houses of IarIianenl during lhe Session
vas 7.
pIans lo repair lhe sIacken econony. The Insurance
and Iension reforns liII proposes lo hike lhe Ioreign
Direcl Inveslnenl (IDI) cap in lhe insurance and
pension seclor fron 26 lo 49 vhich in lurn is
expecled lo give lhe required loosl lo lhe insurance
seclor and lhe econony.
IRDA relaxes proof of residence norms for micro-
insurance products
Dcccm|cr 31, 2012
The IRDA has decided lo reIax lhe requirenenl
of vrillen conhrnalion fron lanks as a proof of
residence for nicro-insurance poIicy seekers fron
ruraI regions. According lo IRDA, lhe requirenenl
of providing vrillen conhrnalion fron lanks vas
hanpering hnanciaI incIusion neasures.
Il has cone lo our nolice lhal cusloners in
renole areas vho have Iiniled access lo lanking
faciIilies have difhcuIly in providing such vrillen
conhrnalions fron lanks, lhe insurance reguIalor
said in a nolihcalion.
Reforms Tracker
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The Policy Pulse
85
Thc BankIng Laws (Amcndmcnt) BI!!, 2011
IICCI veIcones lhe passing of lhe anking
(Anendnenl) iII, 2O11. This iII is an inporlanl piece
of IegisIalion lhal viII Iay lhe foundalion for nany
reforns in lhe Indian lanking seclor.
IICCI hopes lhal aII olher enalIing faclors as
prescriled ly RI are soon fuIhIIed so lhal nev lank
Iicenses nay le issued lo lhe privale seclor. This viII
heIp expand lhe reach of lanking services lo lhe
hnanciaIIy excIuded. Nev lank Iicenses viII aIso
provide an exceIIenl inpelus lo lhe Covernnenls and
RIs hnanciaI incIusion agenda, said Ms. Naina LaI
Kidvai, Iresidenl, IICCI.
The iII furlher cIarihes lhe roIe of RI and lhe
Conpelilion Connission of India (CCI) in lerns of
nergers and acquisilions lhal lake pIace in lhe lanking
induslry. This cIarihcalion niligales lhe reguIalory
overIaps lhal have so far exisled lelveen RI and CCI in
lhis regard. This viII heIp lhe induslry in execuling lheir
lransaclions vilh grealer ease and efhciency.
Bills Introduced In
Lok Sabha
Bills Passed By Lok
Sabha
Bills Introduced
In Rajya Sabha
Bills Passed By
Rajya Sabha
Bills Passed By
Both Houses
1. The Coal Mines
(CnnscrvatInn and
Dcvc!npmcnt)
Amendment Bill, 2012
2. The Central
Universities
(Amcndmcnt) BI!!,
2012
3. The Criminal Law
(Amcndmcnt) BI!!,
2012
4. The Competition
(Amcndmcnt) BI!!,
2012
5. The Appropriation
(Nn.4 ) BI!!, 2012
6. The Governors
(Emn!umcnts,
Allowances
and PrIvI!cgcs)
7. The Constitution
(5chcdu!cd TrIbcs)
Ordcr (5ccnnd
Amcndmcnt) BI!!, 2012
1. The Prevention of
Money Laundering
(Amcndmcnt) BI!!, 2011
2. The Unlawful Ac-
tIvItIcs (PrcvcntInn)
3. The Enforcement of
Security Interest and
Recovery of Debts Laws
4. The Appropriation
(Nn.4) BI!!, 2012
5. The Constitution
(Onc Hundrcd EIgh-
tccnth Amcndmcnt)
Bill, 2012
6. The Banking Laws
7. The Companies Bill,
2012
1. The Child
Labnur (PrnhIbItInn
and Rcgu!atInn)
Amendment Bill,
2012
2. The Indecenl Rep-
resenlalion of Wonen
(Irohililion) Anend-
nenl iII, 2O12
1. The North
Eastern Areas
(RcnrganIsatInn)
Amendment Bill,
2012
2. The Irevenlion of
Money- Laundering
(Anendnenl) iII,
2O12
3. The Conslilu-
lion (One Hundred
Sevenleenlh Anend-
nenl) iII, 2O12
4. The Approprialion
(No.4) iII, 2O12
5. The Conslilulion
(One Hundred Ligh-
leenlh Anendnenl)
iII, 2O12
6. The UnIavfuI
Aclivilies (Ireven-
lion) Anendnenl
iII, 2O12
7. The anking Lavs
(Anendnenl) iII,
2O12
8. The Lnforcenenl
of Securily Inler-
esl and Recovery
of Dells Lavs
(Anendnenl) iII,
2O12
1. The North
Eastern Areas
(RcnrganIsatInn)
Amendment Bill,
2012
2. The Irevenlion
of Money-Launder-
ing (Anendnenl)
iII, 2O12
3. The Appro-
prialion (No.4) iII,
2O12
4. The Conslilu-
lion (One Hundred
Lighleenlh Anend-
nenl) iII, 2O12
5. The UnIavfuI
Aclivilies (Ireven-
lion) Anendnenl
iII, 2O12
6. The anking
Lavs (Anend-
nenl) iII, 2O12
7. The Lnforcenenl
of Securily Inler-
esl and Recovery
of Dells Lavs
(Anendnenl) iII,
2O12
Winter Session, 2012
The Policy Pulse
86
WhiIe lhe conlenlious cIause of aIIoving anks lo
lrade in connodily fulures has leen renoved fron
lhis iII, IICCI is hopefuI lhal lhis aspecl viII conlinue
lo renain on lhe Covernnenls reforn agenda and
viII le addressed as and vhen lhe IarIianenl cIears
lhe Iorvard Markels Connission Acl, an acl lhal viII
provide lhe reguIalor of lhe connodilies narkel vilh
grealer pover.
IICCI is conhdenl lhal lhe passing of lhis iII viII
encourage foreign inveslnenl in lhe lanking seclor.
IICCI congraluIales lhe Covernnenl on lhe lineIy
passing of lhis iII. This viII no doull heIp in sleering
lhe Indian econony lack lo an increased grovlh
lrajeclory.
Enforcement of Security Interest and Recovery of
Dcbts Laws (Amcndmcnt) BI!!, 2011
Through lhe Lnforcenenl of Securily Inleresl and
Recovery of Dells Lavs (Anendnenl) iII, 2O11,
lhe governnenl has anended lhe Securilisalion and
Reconslruclion of IinanciaI Assels and Lnforcenenl
of Securily Inleresl (SARIALSI) Acl and Recovery of
Dells due lo anks and IinanciaI Inslilulions (RDI)
Acl. This slrenglhens lhe reguIalory and inslilulionaI
franevork reIaled lo lhe recovery of dells due lo
lanks and hnanciaI inslilulions.
A sIoving econony has increased lhe IeveI of
lad dells in lhe syslen and forced nany lanks lo
underlake corporale dell reslrucluring. Cross non-
perforning assels (NIAs) in lhe lanking syslen
vere around 3.5 of lhe lolaI al lhe end of lhe hrsl
haIf of lhis hscaI, according lo governnenl eslinales.
CunuIaliveIy, lanks reslruclured `1.9 lriIIion of Ioans
liII Seplenler.
anks and hnanciaI inslilulions (IIs) have leen
facing nunerous olslacIes in lhe recovery of defauIled
Ioans on accounl of deIays in lhe disposaI of recovery
proceedings. The governnenl, lherefore, enacled lhe
RDI Acl in 1993 and SARIALSI Acl in 2OO2 for lhe
purpose of expedilious recovery of non-perforning
assels (NIAs) of lhe lanks and IIs.
AIlhough lhese lvo Iavs are ained al reducing
lad dells, lanks have senl cerlain suggeslions for
furlher slrenglhening of secured credilor righls. The
nev lanking Iav viII aIso enalIe lanks lo inprove
operalionaI efhciency, depIoy nore funds for credil
dislursenenl lo relaiI inveslors and hone Ioan
lorrovers vilhoul fears over recovery.
Under lhe currenl Iavs, lanks can underlake
corporale dell reslrucluring and converl sone
of lhe dell inlo equily according lo prescriled
guideIines. ul no such oplion vas avaiIalIe for assel
reconslruclion conpanies (ARCs). They acquire lad
dells fron lanks and olher Ienders al a discounl and
lhen lry lo recover lhen.
The Companies Bill, 2012
IICCI veIcones lhe passage of lhis inporlanl iII
ly lhe HonlIe Lok Salha. The nev iII is progressive
and adopls lesl gIolaI praclices. As India Inc. is fasl
leconing a favoured inveslnenl deslinalion, lhere
vas an inperalive need lo overhauI lhe archaic
Conpanies Acl lhal has governed lhe funclioning
of lusinesses in India for over hfly years. Therefore
lhe Conpanies iII cones al a very opporlune line.
Il vouId go a Iong vay in sinpIifying reguIalions
naking il easier for conpanies lo nanage and grov
lheir lusinesses.
The iII inlends lo sinpIify reguIalions, lring
grealer cIarily, accounlaliIily and oversighl in
nanaging lusinesses and laIance various slakehoIder
inleresls incIuding encouraging grealer sociaI
responsiliIily ly prohlalIe corporales, said Mrs.
Naina LaI Kidvai, Iresidenl, IICCI, conpIinenling
lhe Covernnenl on ils dynanic approach in naking
lhe Conpanies Acl as conlenporary and rolusl as
possilIe.
The nev iII has lroughl in nunerous concepls of
governance inlo Iav, vhich shouId uIlinaleIy Iead lo
higher lransparency and leller adninislralion of lhe
corporale seclor. SeveraI nev provisions have leen
inlroduced in lhe iII vhich viII have an inpacl on
lhe funclioning and adninislralion of conpanies.
To nane a fev- CSR, rolalion of audilors, cerlain
cIasses of conpanies lo have vonen direclors,
concepl of independenl direclors and a separale
ScheduIe delaiIing a Code for independenl direclors,
dehnilion of 'pronoler aIong vilh IialiIily in cerlain
cases, Cerlain cIass of conpanies having nuIlipIe
lusiness & separale divisionaI Managing Direclors
can appoinl sane person as Chairnan and Managing
Direclor, reslriclion on nanageriaI renuneralion and
cIass aclion suils. The operalion of lhe iII aIso Ieans
heaviIy on exlensive RuIes, vhich are expecled lo le
pul oul for vider delale lefore lheir nolihcalion.
IICCI has had severaI rounds of very conslruclive
deIileralions vilh lhe Minislry and ils ofhciaIs in
lhe evoIulion of lhe Conpanies iII and vishes lhe
Covernnenl for nany nore posilive inilialives for lhe
grovlh and deveIopnenl of lusiness in lhe counlry.
The Policy Pulse
FICCIs Data Centre
89
FICCIs Data Centre
Indian Economy-An Update
Economic Scenario
In Iine vilh generaI econonic oulIook, Cross Doneslic
Iroducl (CDI) grovlh dipped lo 5.3 per cenl in lhe second
quarler of 2O12-13 fron 6.7 per cenl in lhe sane quarler
during lhe previous hscaI year nainIy oving lo disnaI per-
fornances ly farn and nanufacluring seclors.
A najor sellack lo lhe overaII CDI in Q2 vas poor shov
ly lhe nanufacluring seclor vhich had deaIl a severe lIov
lo lhe induslriaI seclor even in lhe pasl nonlhs. Il aggregal-
ed lo onIy a nere O.8 per cenl grovlh as conpared lo earIier
record of 3.4 per cenl in lhe sane quarler of lhe Iasl hscaI.
Mining and quarrying fared al 1.9 per cenl vhiIe eIeclricily,
gas and valer suppIy al 3.4 per cenl during lhis period in
conlrasl lo 4.1 per cenl and 1O.5 per cenl respecliveIy in Q2
of 2O11-12.
AgricuIlure seclor aIso faiIed lo inpress vilh onIy 1.2 per
cenl grovlh rale. In lhe second quarler of lhe currenl hscaI,
lhis vas a najor nose dive in conparison lo lhe grovlh rale
of 3.1 in lhe Iasl year.
The service seclor vas ly far lhe highesl conlrilulor
lo lhe overaII CDI and has shovn a lrenendous grovlh
conpared lo lhe olher seclors. Conpared lo olher seclors,
proninenl grovlh in Q2 of 2O12-13 over Q2 of 2O11-12 are
conslruclion (6.7 per cenl), lrade, holeIs, lransporl and con-
nunicalion (5.5 per cenl), hnancing, insurance, reaI eslale
and lusiness services (9.4 per cenl) and connunily, sociaI
and personaI services (7.5 per cenl).
In ils ApriI 2O12 IoIicy Reserve ank of India (RI) projecl-
ed CDI grovlh al 7.3 per cenl. This vas revised lo 6.5 per
cenl in lhe hrsl quarler reviev due lo foIIoving reasons
IossiliIily of hanpering doneslic grovlh due lo 1.
gIolaI sIunp
Weak doneslic induslriaI aclivily 2.
SIover grovlh of service seclor 3.
The prediclions unforlunaleIy cane lrue ly lhe line of
Mid Quarler Reviev and lhe econony venl in a graduaI
nose dive in lerns of doneslic grovlh rale. During lhe sec-
ond quarler of 2O12-13 induslriaI oulpul picked up nar-
ginaIIy aIong vilh services Iurchasing Managers Index
(IMI) shoving a decenl inprovenenl. The agricuIluraI
seclor faiIed lo inpress aIlhough lhere vas a nodesl rain-
faII during lhe nonlh of Augusl and Seplenler and couId
nol nalch up lo hgure corresponding lo sane quarler of
Iasl hscaI year. The overaII econonic oulIook faiIed lo pul
a sniIe on lhe inveslors face. Taking cue fron lhese fac-
lors, lhe laseIine projeclion of CDI grovlh for 2O12-13 is
revised dovnvard lo 5.8 per cenl. (Represenled in charl
leIov)
Key Economic Indicators
(CDI) 5.3 - Q 2: 2O12-13
5.5 - Q 1: 2O12-13
(III) CeneraI Index 171.3 for lhe nonlh of Ocloler 2O12 (8.2
higher as conpared lo lhe IeveI in Ocloler 2O11)
WII Inalion () AII connodily: 7.45 (Ocloler, 2O12)
AII connodily: 7.81 (Seplenler, 2O12)
AII connodily: 8.O1 (Augusl, 2O12)
AII connodily: 7.52 (}uIy, 2O12)
Inleresl Rales CRR: 4.25 p.a. (vef 3rd Novenler, 2O12)
ank Rale: 9.OO (vef 17lh ApriI, 2O12)
Reverse Repo Rale: 7.OO (vef 17lh 2O12)
Repo Rale: 8.OO (vef 17lh 2O12)
Lxchange Rale: 54.84 (DoIIar)
88.16 (Iound SlerIing)
71.54 (Luro)
62.5O (}apanese Yen)
(Rales as on 4lh }an, 2O12)
Scurcc. R8|, MOSP|, GO|, Minis|rq cf |inancc, Minis|rq cf Ccnsumcr Affairs
90
FICCIs Data Centre
In0atInn
HeadIine WhoIesaIe Irice Index (WII) inalion (al an av-
erage) conlinued lo renain alove 7.7 per cenl in Q2, nuch
Iike lhe hrsl quarler of lhe hscaI year. Il hgured al 7.52 per
cenl in lhe nonlh of }uIy, shol up lo 8.O1 per cenl in lhe
nonlh of Augusl (peak poinl during lhe quarler) lefore
selling al 7.81 per cenl in Seplenler. Sone signs of recov-
ery vere seen during lhe slarl of lhird quarler vhen il cane
dovn lo 7.45 per cenl in lhe nonlh of Ocloler.
As per RIs quarlerIy reporl, inalion picked up pace in
lhe niddIe of second quarler of 2O12-13 due lo sudden hike
in fueI price and increased price IeveI of non food nanufac-
lured ilens. WII for prinary food arlicIes vas reslrained
ly lhe end of hrsl quarler of lhe currenl hscaI lul sveIIed
in Seplenler oving lo price rise of sugar, edilIe oiIs and
grain niII producls. Rise in fueI price vhich conlinued
fron Q1 vas nainIy due lo a rise in gIolaI crude oiI prices.
Non food nanufaclured producls inalion renain hxed al
5.6 per cenl in Q2. The nev conlined |ruraI & urlanj Con-
suner Irice Index (CII) (ase: 2O1O=1OO) inalion vas high
indicaling luiId-up of food price pressure. CII excIuding
food and fueI groups sIighlIy decIined during Q2. Irovi-
sionaI annuaI inalion rale lased on aII India generaI CII
(Conlined) for Decenler 2O12 on poinl lo poinl lasis (De-
cenler 2O12 over Decenler 2O11) renained al 1O.56 per
cenl as conpared lo 9.9O per cenl (hnaI) for Novenler 2O12
and 9.75 (hnaI) in Ocloler 2O12.
A decIine or al Ieasl slalIe connodily price vilh an ap-
precialing rupee viII heIp lo conlain inalionary pressures
ly lringing dovn lhe rupee cosl of inporls, especiaIIy of
connodilies.
Scrulinizing lhe foIIoving aspecls lhe laseIine projeclion
for headIine WII inalion for March 2O13 is raised lo 7.5 per
cenl fron 7.O per cenl indicaled in }uIy. Lcononisls expecl il
lo rise sonevhal in Q3 lefore leginning lo ease in Q4.
FIsca! DccIt
}usl ahead of lhe Union udgel for lhe nexl hscaI, lop
secrelaries of lhe hnance ninislry asserled lhal lhe hscaI
dehcil viII le conlained al 5.3 of lhe CDI, vhich is lhe
revised udgel eslinale for 2O12-13. The conhdence of lhe
ofhciaIs is lased on lhe governnenl neeling lhe ludgel
largel of disinveslnenls for Rs 3O,OOO crore and lhe expecl-
ed revenue fron speclrun auclions is IikeIy lo le around
Rs 4O,OOO crore, sources said.
TiII Novenler 2O12, lhe hscaI dehcil vas Rs 4.13 Iakh
crore or aInosl 8O of lhe ludgel eslinales in lhe hrsl eighl
nonlhs of 2O12-13. Lasl year lhe governnenl had sIipped
on ils hscaI consoIidalion vilh lhe largel going up ly 1.6.
IinaIIy, 2O11-12 ended vilh hscaI dehcil of 5.7. This year
lhe governnenl had eslinaled hscaI dehcil lo le around
5.1 of lhe CDI, lul Ialer revised il lo 5.3.
Currcnt Accnunt DccIt
Indias currenl accounl dehcil (CAD) vorsened in }uIy-
Seplenler lo hil a record of $22.3 liIIion prinariIy on ac-
counl of a sharp faII in nerchandise exporls ~exporls feII
$7 liIIion quarler-on-quarler (q-o-q) ~ and Iover services
exporls. WhiIe III and IDI ovs lolh rose sharpIy ~ ly $5
liIIion and $9.5 liIIion respecliveIy on a q-o-q lasis ~ lhe
inpacl of lhis vas Iovered sonevhal ly a $4-liIIion con-
lraclion in NRI deposils lelveen lhe }une and Seplenler
quarlers.
Al lhis IeveI, lhe CAD is a record 5.4 of gross doneslic
producl, vorse lhan 4.2 in lhe sane period lhe previous
year. Ior lhe nine-nonlh period of ApriI-Seplenler, lhe
CAD slood al $38.7 liIIion or 4.6 of CDI, laIance of pay-
nenls dala reIeased ly lhe Reserve ank of India
IreviousIy, RI Covernor D Sullarao had said lhal a
CAD of around 2.5-3.O is suslainalIe for lhe Indian econ-
ony. Anylhing alove lhal has inpIicalions for lhe slaliIily
of lhe exlernaI seclor.
Tradc DccIt
Lxporls feII ly 12.2 in }uIy-Seplenler as conpared
vilh a 45.3 grovlh in lhe sane period lhe previous year
vhiIe inporls feII narginaIIy ly 4.8 conpared vilh a rise
of 38.1 in lhe previous year. The governnenls decision
lo hike inporl duly on goId in }une seened lo have nol
Scurcc. R8| Scurcc. R8|
91
FICCIs Data Centre
had a lig inpacl as goId inporls slood al $1O.46 liIIion, a
faII of jusl$1 liIIion fron lhe previous quarler. Oving lo
lhe sharp faII in exporls and a ralher snaII faII in inporls,
lhe lrade dehcil videned lo $48.3 liIIion fron $44.5 liIIion
a year ago.
During }uIy-Seplenler, lhe hnanciaI accounl surpIus
vas $24.24 liIIion, up fron $19.O1 liIIion a year ago, IargeIy
due lo higher foreign direcl inveslnenl.
Nel IDI ovs rose lo $8.9 liIIion, up fron $6.5 liIIion a
year ago vhiIe lhe nore voIaliIe porlfoIio ovs vere $7.6
liIIion, up fron $1.4 liIIion a year ago. Inovs incIuding
LCs and lank capilaI feII lo $3.3 liIIion fron $9.5 liIIion
a year ago.
Rupee Movement
The Indian rupee has slarled 2O13 vilh a lang, vilh 1
per cenl gain in lhe hrsl lvo days of lhe Nev Year on lhe
lack of slrong foreign inovs. The voIaliIily is expecled lo
conlinue as lhe rupee vouId lrack cues fron lhe doneslic
narkels as veII as gIolaI shores.nosl-availed cues in lhe
hrsl quarler of CaIendar Year 2O13 are lhe Reserve ank of
Indias nonelary poIicy neeling in }anuary, foIIoved ly
lhe Union udgel in Ielruary. The RI is videIy expecled
lo cul inleresl rales heIping econonic grovlh. The encour-
aging faclors have leen lhe soflening inalion nunlers,
lhe decIine in crude oiI prices and expeclalion of a good
Rali crop.
Lasl year vas a roIIer coasler ride for lhe Indian unil
vhich ended 2O12 on a veak nole againsl lhe US doIIar for
a second conseculive year. The rupee cIosed 3.5 per cenl
Iover afler hilling a record Iov al 57.32 per doIIar in }une
2O12. Il recovered over 4 per cenl fron lhe Iovs since lhen.
The Indian rupee is lhe lhird vorsl-perforning Asian cur-
rency in 2O12.
Reference:
RI 1.
Minislry of Iinance, India 2.
MOSII 3.
COI 4.
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92
FICCIs Data Centre
> India ranked as lhe fourlh nosl largeled nalion
in AsIa PacIc rcgInn in 2O12 vilh $44.7ln,
narginaIIy dovn conpared $45.1ln announced
in 2O11
> India Outbound M&A voIune increased
signihcanlIy lo $14.8ln in 2O12, up 35
conpared lo 2O11 ($1O.9ln). AIlhough, 1H 2O12
onIy accounled for $2.1ln of lhe lolaI oullound
voIune, 2H 2O12 sav a sleep rise in voIune vilh
$12.7ln
> India Inbound M&A voIune dropped 64 lo
$11.1ln in 2O12 conpared lo $3O.5ln for lhe year
2O11
> ConverseIy, India Domestic M&A voIune slood
al $33.6ln in 2O12, nore lhan doulIe $14.6ln
announced Iasl year
The $9.5ln nerger ly Sesa Coa vilh SlerIile -
Induslries/Cairn India/Madras AIuniniun/
Vedanla Resources announced in 1Q 2O12
vas lhe Iargesl India M&A lransaclion lhis
year and lhe Iargesl India Doneslic deaI on
record
os. Adv|sor Va|ue 5m # Dea|s Share
1 ClLl 18,669 13 41.8
2 Coldman Sachs 12,71S 7 28.4
3 Morgan SLanley 12,4S2 14 27.9
4 !Morgan 11,883 11 26.6
S 8arclays 11,211 9 2S.1
6 8ank of Amerlca Merrlll Lynch 9,168 2 20.S
7 CredlL Sulsse 6,927 4 1S.S
8 !M llnanclal LLd 4,809 3 10.8
9
AmblL CorporaLe llnance vL LLd
3,070 11 6.9
10
Axls 8ank
2,998 10 6.7
Ind|a Announced M&A Adv|sory kank|ng 2012
os. Adv|sor Va|ue 5m # Dea|s Share
1
Chlna
183,400 349S 43.6
2 Slngapore S2,483 374 12.S
3
SouLh korea
47,473 8S8 11.3
4 lndla 44,702 1163 10.6
S
Malaysla
19,184 70S 4.6
6
Pong kong
18,67S 310 4.4
7
lndonesla
17,7S2 279 4.2
8
1alwan
12,310 168 2.9
9
hlllpplnes
9,987 141 2.4
10
1halland
7,203 236 1.7
SL As|a M&A kank|ng by 1arget Nat|ona||ty 2012
Investment Banking Updates
Mergers & Acquisitions
In associalion vilh
93
0
S
10
1S
20
2S
30
3S
1P 2P 1P 2P 1P 2P 1P 2P 1P 2P
2008 2009 2010 2011 2012
$bn Ind|a M&A Vo|ume
uomesLlc lnbound CuLbound
FICCIs Data Centre
> Indian LCM voIune slood al $15.3ln via 1O5
deaIs in 2O12, a 56 increase on lhe $9.8ln raised
in 2O11
> IIO voIune lolaIed $1.3ln in 2O12, dovn 6
fron lhe $1.4ln raised in 2O11 and narks lhe
Iovesl yearIy voIune since 2OO3 ($1.2ln)
ConverseIy, foIIov-on voIu - ne rose
signihcanlIy lo $13.5ln in 2O12 conpared lo
$7.6ln raised in 2O11
> OiI & NaluraI Cas Corp-ONCCs $2.6ln foIIov-
on via lookrunners Cili, ank of Anerica MerriII
Lynch, HSC, }M IinanciaI Croup, Morgan
SlanIey and Nonura vas lhe Iargesl LCM
lransaclion for India in 2O12 and lhe hflh Iargesl
Indian LCM lransaclion on record
Equity Capital Markets
Date Issuer Sector Dea| 1ype Dea| Va|ue (5m) 8ookrunners
2-Mar CnCC Cll & Cas lC 2,S84
Cl1l, 8oAML, PS8C, !M
llnanclal, MS, nCM
23-leb PulC llnance lC 1,927 Cl1l
12-uec nMuC Mlnlng lC 1,089
AxlS, Cl1l, 8oAML, MS,
lClCl
2S-Sep Calrn lndla LLd Cll & Cas lC 929 Cl1l
S-CcL PulC llnance lC 839 Cl1l
17-uec 8harLl lnfraLel LLd ConsLrucLlon lC 767
8oAML, !M, SC8, u8S,
8A8CA, u8, AxlS,
PS8C, kC1Ak
12-CcL
neLwork 18 Medla
& lnvesLmenLs LLd
1elecom lC S12 lClCl, 88S
23-CcL 1v18 8roadcasL LLd 1elecom lC S04 lClCl, 88S
29-!un Calrn lndla LLd Cll & Cas lC 362 Cl1l
27-nov lnduslnd 8ank LLd llnance lC 360
MS, !M llnanclal,
CredlL Agrlcole, PS8C
1op 10 LCM Dea|s |n I2012
94
FICCIs Data Centre
> India DCM issuance reached $46.1ln raised via
476 deaIs, up sIighlIy on lhe $45.9ln raised in
2O11 lul sliII narked lhe highesl annuaI voIune
and aclivily on record
> Corporate IG and Agency londs accounled for
54 and 25 of lhe lolaI DCM voIune vilh
$25.1ln and $11.7ln, respecliveIy for 2O12
Reliance Industries - Ied lhe offshore issuer
lalIe for 2O12 vilh a 14 share, vhiIe Power
Finance Corp lopped lhe doneslic issuer
ranking vilh a 13 share
> India Domestic DCM voIune reached a record
INR1.9Olr in 2O12, up 9 fron lhe INR1.75lr
raised in 2O11. Aclivily vas up 53 lo 444 deaIs in
2O12 fron lhe 29O recorded in 2O11, and narked
lhe lusiesl year on record
> International issuance recorded an aII-line high
of $1O.4ln in 2O12, up 12 fron $9.3ln priced
in 2O11. AIlhough, issuance for 1H 2O12 had
dropped consideralIy lo $2.6ln conpared vilh
$8.Oln for 1H 2O11, voIune lrelIed lo $7.8ln in
2H 2O12
Debt Capital Markets
0 1 2 3 4 S 6
lood & 8everage
1echnology
ofesslonal Servlces
MeLal & SLeel
uLlllLy & Lnergy
nsLrucLlon/8ulldlng
elecommunlcaLlons
Mlnlng
Cll & Cas
llnance
$bn
Ind|a LCM Vo|ume by 1op 10 sectors
l?2011 l?2012
0
20
40
60
80
100
120
0
2
4
6
8
10
12
14
16
18
1P 2P 1P 2P 1P 2P 1P 2P 1P 2P
2008 2009 2010 2011 2012
# $bn Ind|a LCM Vo|ume
lC lC LqulLy - Llnked # ueals
0
S
10
1S
20
2S
0
1
2
3
4
S
6
1P 2P 1P 2P 1P 2P 1P 2P 1P 2P
2008 2009 2010 2011 2012
#
$bn Ind|a Internat|ona| DCM
Corp llC SSA #ueals
0
200
400
600
800
1000
1P 2P 1P 2P 1P 2P 1P 2P 1P 2P
2008 2009 2010 2011 2012
ln8 bn
Ind|a Domest|c Corporate vs IIG
CorporaLe llC
os. 8ookrunner arents Va|ue (5m) No. share
1 AxlS 8ank 6,707 1S0 14.S
2 lClCl 8ank 4,S13 10S 9.8
3 PS8C 3,7S3 71 8.1
4 SLandard CharLered 8ank 3,139 S7 6.8
S Ak CaplLal Servlces LLd 2,983 103 6.S
6 8arclays 2,6S4 60 S.8
7 1rusL lnvesLmenL Advlsors 2,S96 148 S.6
8 ClLl 2,317 20 S.0
9 koLak Mahlndra 8ank LLd 2,129 8S 4.6
10 ueuLsche 8ank 1,789 39 3.9
95
> India loan voIune reached $66.6ln in 2O12,
dovn 25 on lhe $88.8ln in 2O11 and lhe Iovesl
voIune since 2OO9 ($47.1ln)
Leveraged - Ioan voIune reached aII line high
of $49.9ln via 158 deaIs, and up signihcanlIy
on $5.5ln for 2O11
In conlrasl, - Investment grade Ioan voIune
dropped lo a six year Iov of $16.6ln since
2OO6 ($15.3ln)
> Anong lhe corporale lorrovers, CnnstructInn/
Building seclor lopped lhe induslry ranking in
2O12 ($17.1ln) vilh a 28 share
Loan Markets
FICCIs Data Centre
0
20
40
60
80
100
120
140
160
0
10
20
30
40
S0
60
1P 2P 1P 2P 1P 2P 1P 2P 1P 2P
2008 2009 2010 2011 2012
# $bn Ind|a Loan Vo|ume
lnvesLmenL Crade Leveraged #ueals
0
2
4
6
8
10
12
14
0
10
20
30
40
S0
60
1P 2P 1P 2P 1P 2P 1P 2P 1P 2P
2008 2009 2010 2011 2012
$bn
kef|nanc|ng as of Ind|a Synd|cated |oan Vo|ume
volume 8eflnanclng
0 S 10 1S 20 2S
1exLlle
Mlnlng
Consumer roducLs
Chemlcals
1elecommunlcaLlons
Cll & Cas
1ransporLaLlon
MeLal & SLeel
ConsLrucLlon/8ulldlng
uLlllLy & Lnergy
$bn
Ind|a Corporate Loan Vo|ume by Sector
l?2011 l?2012
96
IB Revenue
> India IB Revenue has reached $684n in 2O12,
dovn 28 on 2O11 ($956n) and narked lhe
Iovesl IeveI since 2OO9 ($615n)
> Syndicated Loan revenue accounled for 5O of
lolaI India I revenue in 2O12 vilh $341n. Despile
lhe record share in 2O12, Ioan revenue is dovn 4
fron lhe $357n earned during 2O11
> M&A revenue sav lhe liggesl faII vilh $116n in
2O12, a 6O drop fron 2O11, and represenls lhe
Iovesl fuII year IeveI since 2OO9 ($59n)
ECM fees - accounled for Iovesl share of India
I revenue vilh $84n and a 12 share in
2O12
DCM fees - shoved a consideralIe drop of
37 lo $143n in 2O12, on lhe $228n for 2O11
0
100
200
300
400
S00
600
700
1P 2P 1P 2P 1P 2P 1P 2P 1P 2P 1P 2P 1P 2P 1P 2P
200S 2006 2007 2008 2009 2010 2011 2012
$m
Ind|a Investment 8ank|ng kevenue
uCM LCM Loan M&A
0
2
4
6
8
10
12
14
16
0
1,000
2,000
3,000
4,000
S,000
6,000
7,000
8,000
1P 2P 1P 2P 1P 2P 1P 2P 1P 2P 1P 2P 1P 2P 1P 2P
200S 2006 2007 2008 2009 2010 2011 2012
$m
As|a (ex Iapan) I8 kevenue
lndla as of Asla(ex !apan) as LoLal l8
FICCIs Data Centre
97
FICCIs Data Centre
Markets Watch
98
Financial Sector Events
Synopsis of past events
L lo R: Mr. Zhou Wenzhong, Secrelary CeneraI, oao Iorun for Asia, Dr. Arlind Irasad, Direclor CeneraI, IICCI, Mr. Yasuo Iukuda,
Chairnan, oao Iorun for Asia, Mr. Zeng Ieiyan, Vice Chairnan, oao Iorun for Asia, forner Vice Irenier, China, Mr. Suresh I.
Iralhu, Iorner Union Minisler for Iover , Covernnenl of India & Chairperson of lhe CounciI on Lnergy, Lnvironnenl and Waler,
India, Mr. Sidharlh irIa, Vice Iresidenl, IICCI & Chairnan Xpro
Asian Financial Cooperation Conference
26th- 27th November, 2012, Mumbai
The Conference vas co-hosled
ly IICCI and IA on Novenler
26
lh
and 27
lh
, 2O12 al HoleI Tridenl,
Narinan Ioinl, Munlai, India,
under lhe lhene of Open Asia,
Open Iinance. Top decision-
nakers, reguIalors and CLOs of Iarge
Asian lanks, insurance conpanies,
hnanciaI service inslilulions and
olher slakehoIders vere inviled lo
lackIe lhe chaIIenges of laIancing
innovalion, openness and reguIalion
lhe Asian vay. A vide range of
issues viII le deIileraled upon
during lhe lvo days of discussions,
incIuding gIolaI econonic oulIook
and Asian lransfornalion, hnancing
Asian infraslruclure lhrough capilaI
narkel innovalion, currency svaps
and exchange rale coordinalion,
ITA and Asian econonic
inlegralion, suppIier-consuner-
inveslor diaIogue on energy and
resources and Asian hnanciaI
cooperalion anongsl nany olher
cenlraI lhenes.
The conference vas a high
prohIe knovIedge-sharing and
nelvorking pIalforn. The purpose
of lhis conference vas lo invile
Ieaders fron governnenls, poIicy
nakers, inlernalionaI corporalions
and renovned schoIars and
acadenicians for furlher
cooperalion anongsl Asian in lhe
areas of hnance and inveslnenl and
lo provide an effeclive pIalforn
lo vork oul a road nap for lhe
induslry lhal couId heIp unIeash
lhe lrue polenliaI of lhe seclor.
The conference discussed capilaI
Iiquidily chaIIenges especiaIIy on
hov lo overcone poIicy, narkel
and infornalion lollIenecks in areas
such as luiIding inlernalionaI and
regionaI hnance cenlre, inlernalionaI
nergers and acquisilions and lrade
hnancing lo nane a fev.
Wilh lhis nega evenl IICCI and
IA ained lo creale a credilIe
gIolaI pIalforn lo idenlify lhe key
chaIIenges and conslrainls vilhin
lhe hnanciaI seclor and hov lo
address lhese effecliveIy lhrough
reconnendalions on suilalIe poIicy
reforns and lusiness processes,
lhus paving vay for converling
polenliaI inlo reaIily. IICCI and
IA lhank lhe narquee paneI of
proninenl ninislers, lureaucrals,
reguIalors, corporales, schoIars
and experls fron across Asia vho
galhered al lhis nega evenl.
99
Across
1 Maller of poIicy, perhaps (9)
5 iggie on DaIaI Slreel, allr. (3)
6 19-A counlerparl (3)
8 The credilor halh a leller
nenory lhan lhe ___ (6)
9 IIIL conponenl (6)
1O One of RIs poIicy Ievers (3)
12 19-A counlerparl (3)
14 Casino aclivily, nayle (4)
15 OILC is one, perhaps (6)
18 Lnd of nid Iife` (6)
19 Iealure of nany a corporale
lilIe, in US (3)
21 ig nunler cruncher` (3)
22 Markel operalor OR Nicknane
of recenlIy relired AuslraIian
crickeler (6)
24 Degree for vannale hn. pro (3)
25 1969 evenl for Indian lanks (15)
27 Once a year oulgo (7)
28 Munlai lenchnark (6)
3O Co. Iisling delul (3)
31 WaII Slreel reg. (3)
32 Trade reslriclion (7)
Down
1 28-A, for e.g. (5)
2 Recenl suljecl of direcl cash
lransfer (7)
3 rilish relaiIer SeIfridges
vas lhe hrsl lo inlroduce lhis
securily in 1927, allr. (3)
4 One vilh vesled inleresl` (8)
5 Overseas inveslnenl roule nol
avaiIalIe for alonic energy,
Iollery seclors, allr. (3)
7 Lenders ICU` (3)
1O IopuIar derivalive (4,6)
11 Iarl of RHI (1O)
13 VaIualion nelhodoIogy, allr.
(3)
15 ___ is king! (4)
16 ank lhal vas nalionaIised in
1949, allr. (3)
17 A sludy of ___ reveaIs lhal lhe
lesl line lo luy anylhing is Iasl
year: Marly AIIen (9)
18 Whal lvo is, lul lhree is nol`
(7)
2O Silualion vhere fulures price
rise vilh nalurily (8)
23 When auslerily is in fashion,
perhaps (9)
25 ankers nenesis, allr. (3)
26 Any Tine` (5)
29 Currency vhose synloI
resenlIes Creek epsiIon (4)
1 2 3 4 5 6 7
8 9 10
11 12 13
14 15
16
17 18
19 20 21 22 23
24
25 26
27 28 29
30 31 32
Fintainment Section
Crossword
Notes:
CIues ending in ` inpIy pIay on vords.
Digils in lrackel al lhe end of lhe cIue indicale nunler of Iellers in each vord of lhe ansver.
CIues lhal have an acronyn or allr. or in shorl inpIy lhal ansvers are allrevialed.
Fintainment Section
100
Greenspan Put - The Creenspan
Iul refers lo lhe nonelary poIicy
approach lhal AIan Creenspan, lhe
forner Chairnan of lhe Uniled
Slales IederaI Reserve oard,
and olher Ied nenlers exercised
fron lhe Iale 1987 lo 2OOO. During
Creenspans chairnanship, vhen
a crisis arose and lhe slock narkel
feII nore lhan aloul 2O, lhe Ied
vouId Iover lhe Ied Iunds rale,
oflen resuIling in a negalive reaI
yieId. In essence, lhe Ied added
nonelary Iiquidily and encouraged
risk laking in lhe hnanciaI narkels
lo averl furlher delerioralion.
Dogs of the Dow - Devised ly US
fund nanager MichaeI OHiggins,
lhis slralegy expIoils lhe lendency
for slock narkels lo overreacl lo
lad nevs, vhich lhrovs up cheap
shares. Ians of lhe lheory say lhal
largains can le spolled ly Iooking
for high dividend yieIds - lhe
annuaI dividend as a proporlion of
lhe currenl share price. uy lhese
and you nol onIy gel a lig incone,
lul lhe IikeIihood of capilaI gains
loo vhen share prices recover.
Squawk Box - Iirns use squavk
(1) AccnrdIng tn thc !atcst fnrccasts frnm thc Ccntrc fnr EcnnnmIcs
and Business Research, by 2015 which city is expected to employ
hIghcst numbcr nf nancIa! prnfcssInna!s?
a. Nev York
l. London
c. Hong Kong
d. Singapore
(2) 5ct up by 5wcdcn's ccntra! bank In 1968 and awardcd tn A!vIn
Roth and Lloyd Shapley in 2012, the Nobel Prize in Economic
5cIcnccs Is nfcIa!!y knnwn by whIch namc?
a. The Sveriges Rikslank Irize
l. The AIfred NoleI Irize in Lcononics
c. The Keynes Irize in Lcononics
d. None of lhe alove
(3) UntI! 2000, IndIa's unInn budgct was annnunccd at 5 pm nn thc
last working day of February. What is the name of the Finance
Minister who changed the budget announcement time to
11am?
a. Iranal Mukherjee
l. Yashvanl Sinha
c. }asvanl Singh
d. I Chidanlaran
loxes lo inforn lheir lrokers aloul
currenl anaIysl reconnendalions,
narkel evenls and infornalion
aloul lIock lrades. This Iine of
connunicalion heIps lo keep
lrokers updaled on inporlanl
narkel faclors and aIIovs lhe
hrn lo guide ils lrokers lrading.
WhiIe nany olher forns of
connunicalion have arisen as a
resuIl of lechnoIogy, lhe squavk
lox is sliII used in nosl inveslnenl
lanks and lrokerages.
Scurcc. |ntcs|cpcia.ccm
QuIz
Log on to
http://m.mcx-sx.com
on your internet enabled handset
Currency futures
on your mobile
- Market Info
- Price Watch
- OnIine Charts
Financial Fundas
QuIck quIz tn tIck!c ynur Intcrcst In thc nancIa! wnr!d:
Fintainment Section
101
1. StockTwits
Iind oul vhal lhe resl of lhe vorId is saying aloul lhe slocks you foIIov ly using SlockTvils.
You can Iinil lhe connenls lo lhe slocks you foIIov or receive aII lhe lveels.
IIus, users can chal vilh olher inveslors, gel cuslonized hnanciaI nevs, and see slock charls and videos vilh lips on
invesling.
AvaiIalIe for iIhone, Iackerry, iIad
2. FRED
Cives users free access lo lhe liluIar IederaI Reserve Lcononic Dalalase.
Wilh feeds lo nore lhan 6O,OOO slreans of dala fron 48 differenl sources, IRLD dravs on governnenl dala fron
IocaI, slale and nalionaI governnenls, inlernalionaI dala and privale hrns. Calegories incIude CDI, unenpIoynenl,
dell and olher seclors of lhe econony and governnenls across lhe vorId.
Android and iOS (oplinized for lolh iIhone and iIad)
3. IRDA
LnalIes conparison of Unil Linked Insurance IoIicies (ULIIs) inlroduced on or afler 1sl Seplenler, 2O1O, vhen lhe
nev ULII guideIines cane inlo force.
ReaI-line access lo IRDAs reposilory of ULIIs
Conpare fealures of ULIIs Iike preniun and lenehls
Search ly Conpany, ly IoIicy lype and ly Keyvord
Works on Android, iIhone, Nokia and Iacklerry pIalforns
QuIck !nnk at nancIa! apps
Mangesh Sakharan Chogre, an aIunnus of V}TI and NMIMS, is a professionaI inveslnenl
lanker vilh a passion for equily narkels and vords aIike. He is a cruciverlaIisl and an
inlernalionaI crossvord conslruclor vilh crossvords pulIished in WaII Slreel }ournaI,
Los AngeIes Tines and recenl acceplance ly The Nev York Tines. He has lhe unique
dislinclion of leing lhe hrsl and lhe onIy conslruclor fron India lo le inviled ly lhe
Nev York Tines lo le a judge al lhe presligious Anerican Crossvord Tournanenl. He
is aIso a freeIance vriler and his coIunns have leen pulIished in Ieading daiIies Iike
The Lcononic Tines, The Hindu usiness Line, Deccan HeraId and The Tines of India
- incIuding ils nuch-foIIoved Speaking Tree coIunn. His pulIished vork is avaiIalIe al
vvv.nangeshghogre.con
QucstInn. 1
a. DLHLC
l. SIHICNHI
c. CNTIAR
d. ARRARL
e. OOIUNC
f. Measure vhich caIcuIales risk
adjusled relurn ly a nuluaI
fund : ______________ (5,5)
QucstInn. 2
a. OAILT
l. SALLL
c. NOIALIITN
d. ICLAITA
e. AOIRCYT
f. Much used lern lo descrile
Anericas nounling dell
silualion _______ (6, 5)
QucstInn. 3
a. UITDLAL
l. LLWHAT
c. LTURNR
d. AINRCM
e. One vhose lusiness is lo lakes
olhers risks for a fee : ___ (11)
Jumble
5n!vc thc 5 jumb!cd !cttcrs tn fnrm 5 nancIa! tcrms. Thc cIrc!cd !cttcrs In thcsc tcrms
can bc rcarrangcd tn fnrm a pnpu!ar nancIa! buzz wnrd(s) hIntcd by thc c!uc.
Mangesh Ghogre
Fintainment Section
Credits
Fintainment Section
102
I
1
N S
2
U R A
3
N C
4
E F
5
I I P
6
L C
7
N U D R D D
D
8
E B T O R E
9
Q U I T Y C
10
R R
E S D A
X I I P
11
L
12
T D
13
D
14
E A L T C
15
A R T E L C
R
16
Y O A O O F
B E
17
C
18
R I S I S P
I
19
N C
20
C
21
F O H P
22
U N T E R
23
O O M
24
B A E I E
N N P C O C
N
25
A T I O N A L I
26
Z A T I O N E
P A M N S U S
A
27
N N U I T Y S
28
E N S E
29
X S
G C U U I
I
30
P O S
31
E C E
32
M B A R G O O
O N
Answers of QuIz
Answer: 1 - c
Answer: 2 - a
Answer: 3 - l
Answers of Jumble
Answer 1: a - HLDCL, b - IHISHINC, c - RATINC, d - ARRLAR, e - COUION, f - SHARIL RATIO
Answer 2: a - ILOAT, b - LLASL , c - INILATION, d - CAIITAL, e - IACTORY, f - IISCAL CLIII
Answer 3: a - DLIAULT, b - WLALTH, c - RLTURN, d - MARCIN, e - UNDLRWRITLR
Solution of Fintainment Section
Fintainment Section
Established in 1927, FICCI is the largest and
oldest apex business organisation in India,
FICCIs stand on policy issues is sought out by
think tanks, Government and academi.
Why Partner with FICCI
Why nol` Where eIse couId you:
u Inuence governnenl IegisIalion and poIicies
u e parl of IICCIs lhoughl Ieadership inilialives
u Cel pulIicily lhrough parlicipalion in lrade fairs and
exhililions
u Slay inforned lhrough various pulIicalions and culling
edge sludies
u AvaiI of discounls on deIegales fees
u Connecl vilh 2,25OOO nenlers fron lhe pulIic and
privale seclors vho IICCI represenls direclIy or
indireclIy
If already with Ficci, read on to know
what else awaits you:
u InlernalionaIIy accIained pIalforns lo neel foreign
poIilicaI and lusiness Ieaders
u AliIily lo nake represenlalions lo Covernnenl and
Inslilulions
u Inleraclions vilh Iike-ninded luyers and seIIers
u A dedicaled heIpIine
u Infornalion on exporl and inporl poIicies
u Choice of exhililions and audiloriun faciIilies
For any Feedback, Comments,
FICCIs Membership & Advertisements in
Financial Foresights
IIease conlacl:
Mr. Apoorv Srivastava
Editor-Financial Foresights
QuarlerIy IulIicalion
IICCI-IinanciaI Seclor
Iederalion House, 1, Tansen Marg
Nev DeIhi 11O OO1
TeI: 91-11-2373876O-7O
91-11-23487424 (D)
Iax: 91-11-2332O714, 237215O4
LnaiI: apoorv.srivaslavahcci.con,
Welsile: vvv.hcci.con
INDUSTRYS VOICE FOR POLICY CHANGE
FEDERATION OF INDIAN CHAMBERS OF COMMERCE AND INDUSTRY
|nus|rqs Vcicc fcr Pc|icq Cnangc
Financial Sector Division
Federation House, 1 Tansen Marg, New Delhi - 110 001
Ph: 011-23487424, 524, Fax: 011-23320714, EmaI!: nanccccI.cnm
www.ccI.cnm

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VOL. NO. 3 ISSUL NO. 3 Q3 IY 12-13

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