Banks urge exporters to unwind Re-$ options

Days ahead of the close of the financial year, many banks are pushing exporters to unwind rupee-dollar options contracted towards the end of 2007 for protecting their dollar receivable from a sharp appreciation in the rupee.

According to dealers, struck by the continuous appreciation of the rupee against the dollar last year, most of the exporters had bought dollar-rupee options to protect the rupee-denominated value of their receivable.

While such contracts were struck at around 39.50 to a dollar, the rupee depreciated to 40.70 in January-February 2008. "This was not apprehended by exporters, which is why most of the options ran out of money when the rupee started depreciating," said a dealer.

The rupee-dollar option is a derivatives product that allows exporters to hedge their rupee-dollar exposure. Most of the companies struck options, which enabled them to book dollars at a higher value (at Rs 39.70/dollar) when the market was ruling at 39.50.

However, the currency started moving in the reverse direction since the rupee depreciated and so the option ran into losses. The rupee depreciated as foreign institutional investors (FIIs) pulled away from the Indian equity market since January 2008.

Besides these dollar options, another structure that may trigger alarm for companies is the Libor-linked (London Inter-Bank Offered Rate) options struck by companies to hedge the interest rate volatility arising from dollar-denominated borrowings. According to dealers, many companies have bought structures to hedge the interest rate risk along with the currency risk. While companies shift the currency risk by shifting from a volatile currency to a stable one, it also hedges the interest rate risk arising on foreign currency borrowings by shifting from the dollar Libor to the sterling Libor.

While the dollar Libor for six months rose from a low of 3.13 per cent in 2005 to 5.07 per cent in 2007, in the same period the sterling Libor for the same maturity fell from 5.07 per cent to a low of 4 to 4.66 per cent.

However, contrary to the expectation of stable rates, the sterling Libor has now firmed up to 6 per cent. Libor is the international interest rate benchmark.

While the dollar Libor, pooled through interest rates on the dollar in the US market, is used for borrowings denominated in the dollar, the sterling Libor is based on interest rates in the pound sterling to be used as the benchmark for borrowings to be made in the British currency.

These products have also started going out of money (into losses with a sudden rise in the Libor interest rates in the pound sterling.

Banks and companies have now been exposed to an adverse movement in currencies as well as interest rates (sterling Libor) under exotic structures, where they had swapped dollar liabilities into more stable currencies like the Swiss franc or the dollar interest into the pound interest rate under Libor.

Now no bank wants to make any more mark-to-market losses for any other losses even if companies are losing. Banks do not lose in such deals as they take a cover (hedge for all such contracts) under RBI guidelines. It becomes a credit risk for banks if companies do not pay the cash flows if the option is out of money.