Hedging in commodities has remained confined mostly to traders and that too only in a handful of commodities. Small and medium enterprises have started hedging their costs on commodity futures exchanges but large companies are yet to do it. They may have their own arguments such as a lack of depth in futures. But it will also be in the interest of banks to encourage their clients including large companies to hedge risks as commodity prices have turned volatile and it affects their lending. If that cost can be hedged, it would be a win-win for all stakeholders.
The question assumes significance as hedging foreign exchange exposure is top on the agenda of every corporate, traders and even all regulators and professional bodies. All those who are connected with forex exposure and its hedging are connected with commodity exposure directly or indirectly but nobody talks about the risks of unhedged commodities.
While banks are interested in hedging commodity exposures of their borrowers, the Reserve Bank of India is not allowing it saying that the commodity market regulator doesn’t have enough powers and teeth. Most believes that once the bill seeking to amend the Forward Contract Regulation Act (FCRA) is passed by the Parliament which is likely to happen soon, RBI will allow banks to hedge commodity risk on behalf of their clients.
In fact there is a need for doing much more than simply allowing banks to hedge such risks.
For example banks, without waiting for RBI’s permission to hedge risks directly on exchanges, can tell borrowers that if commodity price (raw material cost) risk is hedged then the credit score would be higher and interest rates could be lower as at least raw material price risk is hedged. Only one or two private banks are understood to have initiated asking this to borrowers.
If there are losses and gains on account of foreign exchange exposures because of changing values of currencies, there are accounting standards and provisioning norms. These norms make risk related to forex exposure transparent and keep companies disciplined in terms of taking suck risks. While, commodity price risk, which is raw material price risk, is equally serious but no one is asking about that.
Why are professional bodies not thinking about such norms for commodity risks and why can there not be accounting disclosures regarding hedged and unhedged commodity price-related risks? Companies consume agri and non-agri commodities and are also affected in one or the other way due to energy price risks. All these can be hedged, which is not happening perhaps because the law doesn’t demand it.
Analysts, be they from broking houses or from other areas like ratings etc, should also raise the issue of unhedged commodity price exposure. Banks are already lending to companies based on warehouse receipts for goods deposited in warehouses of exchanges and if the commodity is hedged on the exchange as in such cases the price of commodity has been fixed because of hedging. Rubber is the best example of this as it is the showcase example of the futures industry.
Hedging by companies has been happening on futures exchanges but on a very small scale. Sugar and edible oils are other examples where companies have been active on bourses for hedging their exposures. In many other commodities like metals and even spices, SMEs are actively hedging their risks. But looking at the scope and need for hedging commodity exposure all many more things need to be done.