Jamal Mecklai: The new game in town

MARKET MANIAC

Last month's glorious surge in the rupee has made believers of all but the very close-minded. The possibility that the rupee has reversed its decade-long downtrend "" it fell from around 13 to the dollar in 1991 to nearly 50 to the dollar in 2002, a loss of nearly 75 per cent of its value "" has now become part of most corporate strategy briefs.

Most companies first started thinking of the strategic implications of rupee strength around August or September 2002. The rupee had only strengthened a little bit "" from 49 to around 48.50 "" but the previous financial year had seen a real vicious squeeze on margins and the stunning collapse of equity prices as a result of the bursting of the IT bubble.

Unsurprisingly, the IT sector was early off the block "" unsurprisingly because rupee weakness had played a significant role in their continually strong margins.

After a few months of disbelief, rupee bullishness was quickly assimilated and by the end of that year, many of the top-end IT "" and other "" companies were selling their receivables forward quite aggressively. Some of them set up policies to keep 12 months forward receivables sold; one of our clients even proposed a policy of selling up to three years' forward, which, unfortunately as it turned out, was nixed by its board.

However, few companies really built business scenarios incorporating long-term rupee strength. Rather, with business improving and the new sell on Day 1 policy in place, many companies rode out the continuing wave of rupee strength for most of 2003, enjoying the profit boost from the gains in "other income".

Now, however, (almost) everybody and his brother has bought into the belief that (a) the rupee is on a secular uptrend, which could last for years, and (b) RBI's efforts to keep market volatility down are reaching a limit. Note that (b), above, queers the pitch, since it suggests that simply selling forward as far as the eye can see may, from time to time and possibly oftentimes, result in opportunity losses.

Clearly, this new forex environment requires a whole vista of strategic responses, which would be different for different companies. A company strongly vested in the domestic market "" HLL, for instance "" would need to plan for continuing top-line pressure, since a strong rupee would keep inflation contained. Companies with significant net exports need to manage their receivables much more carefully.

For instance, several companies maintain EEFC balances to cover near-term payables, largely to avoid in-and-out transaction costs. Anyone who was running this policy at the end of last month ended up losing over 1 rupee per dollar, far more than even the most extravagant transaction costs. Recognising that inter-day volatility can now be higher than transaction costs should render EEFC accounts (certainly at the current zero interest) much less attractive.

Another strategic response that is gaining currency is to shift receivables out of dollars and into euros, pounds, etc. I think this is a bad idea. First off, international markets are extremely volatile and it is even more difficult to predict medium-term trends than in the case of INR/USD.

I believe that sound management practice requires companies to maintain their P&Ls at the lowest possible volatility. This means that you should invoice your exports in the lowest volatility currency, rather than one that you believe will strengthen.

This gives INR pole position (zero volatility), with USD second (around 2 per cent) and everybody else very far behind. (Invoicing exports in rupees, while a lovely dream, is unlikely to become much of a reality till RBI permits non-residents to access the domestic forex market "" hint, hint.)

Once your receivables are set in USD and you believe there is opportunity in, say, USD/EUR, you could enter into a cross-currency transaction to try and capture this value.

The important point is that since you have clearly entered into a speculative transaction, your management of it would be a lot more focused. If you simply had your exports invoiced in euros, your management of the risk would likely be a lot looser "" I have certainly seen this time and again.

Of course, in many instances, exporters do not have the luxury of selecting the currency of invoicing; in such cases, where receivables are denominated in non-dollar currencies, companies need to fix a target cross rate as soon as the export order is confirmed and protect this rate with an option or a forward or, at very least, with a strongly pro-active treasury.

With technology continually squeezing profit margins in every industry and, now, with a resurgent and volatile rupee, I believe that Indian companies have to ensure that their treasuries are stronger and better structured so as to more effectively insulate business operations from market volatility. This means that profit oriented treasuries have to become the new game in town.

RBI, of course, has to do its part by loosening some now-unnecessary constraints. For instance, companies should be allowed to hedge the translation risk on their balance sheets created by overseas holdings, recognising, of course, that these hedge transactions would have to be cash settled. Prohibition on rebooking cancelled derivative contracts should be lifted. And decisions on whether or not to take speculative positions that is, in excess of actual contracts or 50 per cent of last year's turnover or whatever "" should be left to a company's board.

jamal@mecklai.com