foreign currency contract whereby the buyer and seller exchange equal initial principal amounts of two different currencies at the spot rate. Foreign Debt: Foreign debt can be used to hedge foreign exchange exposure by taking advantage of the International Fischer Effect relationship.
2.0 CONTEMPORARY ANALYSIS
“ Global and domestic outlook has worsened since the time of publication of the previous FSR. The Euro area sovereign debt problem is continuing to weigh on global recovery. Although slowing global growth has dampened commodity prices, heightened risk aversion and the resultant slowing of capital flows are likely to adversely impact emerging and developing economies( EDEs)”- RBI ' s Financial stability Report, June 2012.
According to a survey conducted by RBI, the various systemic risks perceived by the market participants, for 2010-11, were the highest due to market volatility( Exhibit 3). The rising economic shocks- structural and cyclical, have lowered the confidence of the global investor.
The Banking Sector Stability Index( BSI) is witnessing a decline and this view is further strengthened by the JPoD( Joint Probability of distress- a measure of the probability of the distress of the entire banking sector of India), which has been showing an upward trend in the mid-term.
Overall, our banking system has been much appreciated, for its efforts to keep us protected from the withering effects of the sub-prime crises. Over time, the efficiency of the banking sector has increased; their nonperforming assets have decreased, and return on assets, return on equity can be seen rising. Financial stability is its implicit objective, under the RBI Act, 1934; several measures have been taken to ensure it, like management of Capital Account and systemic interconnectedness( conservative limits on aggregate inter-banking liabilities, as a proportion of the bank ' s net worth), restrictions and regulations on uncollateralized lending, banks ' exposure to NBFC ' s etc.
In India, the driver for the plummet in overall inflation is decline in food inflation. The WPI, generally, moves in line with the expectations formed by the household. In December 2012, where the world is looking up to the emerging economies, comes the relief of policy action by the Parliament, putting into place FDI in multi-brand retail, amendments into the Land Acquisition Bill. Indian economy is seen to go through the bottom of the recovery phase, with a stagnated GDP growth rate at 5.3 %( projected); IIP giving its own scary numbers; inflation witnessing a slump; exports shrinking due to world market outlook.
There even came a situation when we were about to lose our BRICS investment grade status; due to our ineffective public policy making and implementation. Talking about the kinds of risks faced which have dampened the investment sentiments for India; include monsoon deficit, the ousting due to power shortage( which blackened 20 out of the 28 states in India), the risk of contagion due to the Euro Crisis, the US fiscal cliff, cut in rating by S & P. S & P had cut its growth rate estimate of countries like China, Japan & Singapore by 50 basis points, however it cut India ' s forecast by 100 basis points, in September 2012.
Amidst all these forecasts, comes the question,“ Where are we heading to and what is required to achieve our objective?” Our financial sector needs continuous evolution and policy reforms. The counter-cyclical policy measures by the RBI are now acknowledged globally.
Commercial banks are becoming hesitant in lending to the infrastructure companies due to the tenure and the default risk associated, and given the current market economy status, ECB( European Commercial borrowings) have dried up, scope of borrowing via FCCBs( Foreign currency convertible bond) has further decreased. Development of this market will lower down the costs of debt and will increase transparency and efficiency in capital markets.
3.0 INTER SECTIONAL ANALYSIS: CORPORATE HEDGING STRATEGIES
A detailed study of the financial statements of several companies from varying industry sectors was conducted and their investment and hedging behaviour was studied. Strides Archolab, Tech Mahindra, Tata Steel were the companies analysed as shown in Exhibit 4 and their forex exposure was mapped with their hedging strategy to find out a pattern.
Exhibit 5( A) depicts the total foreign exchange earnings as a percentage of the total revenue. The four companies analyzed here have a very high dependence on other countries for their revenues, with the average being around 85 %. Since the percentage is so high, a slight drop in the exchange rate may result in huge losses for the companies. Since most of the companies are export oriented, they hedge their risk by entering into derivative contracts with the respective counter parties based upon their underlying assets. Exhibit 5( B) depicts the relationship of companies who have high foreign currency earnings with the interest earned on their debts. The companies in India generally do not raise debts in the international market and hence are protected against any risk arising thereby. However, this is not encouraged since companies can enter into forward contracts with international banks with relative ease.
3.1 TOURISM & HOSPITALITY SECTOR Importance of foreign exchange management in this
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