The Reserve Bank of India (RBI) has come down heavily on India Inc for not prudently using hedging tools available to them. Rather, the hedging instruments are often used to trigger instability in the market.
Commenting on whether the corporate sector had failed to take a “well-deliberated and calculated call”, when it came to hedging, RBI’s executive director, G Padmanabhan, said the corporate sector had become complacent regarding the rupee’s stability, particularly during 2009-2011 when the Indian currency was range-bound between 44-46 a dollar.
“Hedging instruments have become weapons in the hands of corporates to trigger market instability,” said Padmanabhan, while speaking at the Annual Forex Assembly of the Forex Association of India in Goa over the weekend. He said these instruments had been used by corporates for their own profits rather than to manage their business.
“Whether it is past performance-based booking or cancellation and rebooking or Exchange Earners’ Foreign Currency accounts, the corporatex deemed these instruments as unfailing profit channels rather than flexible operational tools to manage real-life business events. These instruments have a tendency to exacerbate volatility in the markets and create a constant undercurrent of instability. That is why RBI had to step in to moderate volatility and cushion the rupee fall,” he said.
Padmanabhan further explained that complacency reflected in their attitude towards the rupee levels. This led to corporates, in terms of hedging, not taking a well deliberated and calculated call for hedging. “A good bit of sales talk from various analysts (and some bankers, too) convinced then that hedging is an unwarranted cost imposed on the business when the rupee is so well-behaved. It is like saying that life insurance is of no value since you are alive today,” he added.
He has called for a comprehensive framework for risk management of companies and the decision to hedge or not to hedge should flow out of a conscious assessment of risk and the costs and consequences of entering a zero, partial or full hedge. He pointed that hedging strategy should be part of a well-conceived risk management framework built around assessment of risk and risk appetite.
“Having bought certainty through a hedge, the agent should be free to concentrate on his chosen line of activity without bothering about the potential gain or loss on account of currency movement. Having bought a car insurance, one should not regret that no accident has taken place,” said Padmanabhan. He said if accounting rules stood in the way of agents’ adopting a hedging strategy that economic rationale hold optimal, there was a need to re-look at this inconsistency.
Speaking about rupee, Padmanabhan said its depreciation was not surprising taking into account the current account deficit that India was facing and slowdown in autonomous capital flows. “It needs to be recognised that increased volatility in the financial markets has become a way of life — a kind of new normal — and it has to be accepted as such,” he said.
Padmanabhan also opined that the responsibility of banks has been underscored in ensuring that hedging products used by clients are in consonance with the economics of their exposure as well as their risk management strategy. “The banks’ responsibility to ensure appropriateness of the product for the client is not merely to satisfy a regulatory mandate nor is it motivated by altruism. Foreign exchange business in India is a part of relationship banking and it is in the banks’ interest that clients do not end up taking unwarranted risk through ill-understood and inappropriate hedging products,” he said.
Commenting that a large number of small, micro and medium enterprises (SMEs) and customers are not getting fair rates for their hedging transactions and banks should offer finer rates to SME clients. He said SMEs felt that they were faced with a 'rip-off', as a large number of SME customers in this country were not getting fair rates for their hedging transactions.
Padmanabhan called for synchronising regulations for the over-the-counter and the exchange traded markets. He said that though competing market segments as competition would bring in more efficiency, the competition was not fair since the playing fields were completely asymmetric. This, he said, needed to be synchronised, perhaps with a road map over an acceptable time span.
