The past two years have been quite tumultuous for the Indian economy. A shaky coalition government at the centre led to a period of policy paralysis and uncertainty. At the same time, the pressure following the global financial crisis was also evident in the economy. Even with a robust banking system, a heavily regulated financial market and an uncompromising central bank, India found itself with extreme currency volatility and inflation over the past two years.
This situation looks set to change for the better since a stable government headed by Prime Minister Narendra Modi came to power earlier this year. Modi, who promised pro-business reforms during his election campaign, has revived confidence in the business community. However, Indian corporate treasurers still face challenges.
The Indian rupee made headlines last summer when it fell drastically, bringing misery to the Indian treasurers. Between May and August 2013, the rupee depreciated 19.4% against the US dollar. This was the biggest fall against dollar since 1990. Since September 2013 the rupee has slowly been recuperating. However, while the rupee seems to be appreciating against the dollar, if you look at a six-country average or a 36-country average, the rupee is still depreciating.
India tightened its monetary policy as an immediate measure to shield against volatility from the Federal Reserve’s plan to abate its bond purchase programme. The Indian central bank, the Reserve Bank of India (RBI), further rolled out policies to attract capital flows and overseas borrowings, particularly with regard to the window for banks to swap their fresh foreign currency non-resident (FCNR(B)) dollar funds with Reserve Bank bolstered reserves. RBI also took measures to curb gold imports to reduce the current account deficit. With a stable government now at the centre, expectations of better policy coordination and implementation are having a positive impact on the markets.
“There is increased optimism in India following the decisive mandate of the new government,” says Aravind Viswanathan, corporate treasurer at Wipro. “We are seeing a measured approach on the part of the regulators to reduce volatility in the macro environment. The approach is business friendly as corporates can plan their operations better without the fear of sharp volatility in currency and interest rates.”
Currency volatility is a major challenge faced by Indian corporates today. As Kuntal Sur, director, financial risk management, KPMG in India stated in a recent report on managing currency and commodity risks, “active management of the risk of fluctuations in the currency market is no longer an option, it is a necessity and vital to maintaining business profitability. The time has come to go beyond ‘crystal ball’ gazing, as the companies that relied on market expert views were left with red on their financial statements. With currencies moving over 10% in a month you do not need a crystal ball; you need an independent risk management process.”
The volatile nature of the currency leads to a dilemma in the mind of the treasurer who has to decide how much to hedge and what the hedge duration should be. Corporates, particularly those in the IT and IT enabled service sectors, do not want to be in a position where they have hedged aggressively and lose out on future profit opportunities. This uncertainty regarding hedging has resulted in a significant increase in the corporates’ unhedged foreign currency exposure. Recently the RBI warned corporates about being complacent with hedging.
To meet with the challenges of an increasingly complex economy, the Modi government’s finance ministry is working on a new monetary policy framework along with the RBI. The framework, which will come out by December 2014, will work towards controlling inflation and volatility.
A Conservative and Cautious Game
India is home to some of the richest treasuries in Asia. Reliance Industries, a conglomerate in the oil, gas and petrochemical space, sat on US$6.1bn of cash as of March 2014. The company’s current investments amount to US$5.56bn, including bank deposits of US$238m. With US$15.1bn as consolidated cash and marketable securities, Reliance is much bigger than some of the banks in the country. A number of other companies, such as the Tata conglomerate, information technology giants Infosys and Wipro, and the automobile maker Maruti Suzuki are all in similar situations.
Unlike their western counterparts, a glance into the investment activities of these Indian corporates tells a story of conservativeness and extreme caution. Maruti Suzuki has around US$1.47bn in long-term current investments like equity, government securities and bonds. These companies prefer fixed maturity plans, exchange traded funds, money market funds and mutual funds to exotic instruments or other risk prone instruments. “We are conservative as far as investments of our surplus funds are concerned,” says Ajay Seth, chief financial officer of Maruti Suzuki. “We would probably look at investment opportunities that are risk-free. In the Indian context you have opportunities available in banks, which gives you a 5-9% returns. So largely the cash is managed without putting it in too much risk.”
Indian companies turned away from derivatives after the global financial crisis. The board of directors at a very large number of companies have prohibited the use of any derivative instrument for hedging of exposures.
Though credit default swaps (CDS) were introduced in the Indian market, the market did not respond positively to the instrument due to the restriction on the netting of the mark to market position against the same counterparty in the context of capital adequacy and exposure norms. Without netting, trades in CDS will be highly capital-intensive as banks and primary dealers have to provide higher capital charges on a gross basis even if they act as market makers and have a ‘positive’ and ‘negative’ position against the same counterparty.
In an effort to rejig the domestic market, the Modi government is considering allowing the Employees Provident Fund Organisation to invest in equity markets. By doing this, the new government plans to ease some of the risk, which may arise due to the concentration of foreign investors in the equity market. If the legislation is passed, some US$1bn may flow into the stock market annually.
Cash Management Woes
With an increasing number of companies expanding to international territories, today’s Indian corporates are faced with cash management challenges of a different sort. Global operations are inherently complex. Multiple regulatory requirements, corporate structuring, time zone differences and multiple banking partners and platforms are some of the challenges in managing global cash. There are also challenges to predict global cash inflow accurately and forecast cash outflows across all departments of the organisation.
For example, in the IT companies that have international offices, transactions between the inter-offices have increased significantly. With the movement of funds happening between two offices and surplus being parked in Indian offices as well as the US offices, the companies find it difficult to optimise the cost of funds and the return on investment.
Therefore, to ensure optimal use of funds, they started drawing borrowings out of those regions. This helped them to ensure that they are able to sustain the cost of those respective geographies. Additionally, it helped them to avoid re-tracking funds or moving funds from India to these other regions. They have started leveraging out of their international offices, thereby simplifying their cash and liquidity management.
Another trend in the cash management space is the setting up of re-invoicing centres. India has a lot of regulatory restrictions when it comes to exploring the other markets for the underlined dollar/rupee play. Hence a lot of companies are setting up re-invoicing centres. These allow corporates to de-risk the Indian balance sheet and to leverage through trade-based finances out of the international offices at far cheaper rates. It also helps them to explore other financial markets – be it for commodities hedging, interest rate hedging or currency hedging.
“Price discovery for some commodity products is far more efficient abroad than in India, says Hemal Shah, partner, advisory services Ernst & Young, India. “It makes more sense in having capabilities set up being abroad. They will have a small team working out of their international offices, which will work as trade invoicing centre cum trading office and help them achieve better objectives.”
For cash management to be effective, visibility of cash available is critical. Many Indian corporates have a very complex bank account structure that diminishes this visibility. The lack the technology to support this type of complex bank account structure is also a hindrance. “If you look at a typical Indian corporate, they would have hundreds of bank accounts, of which at least 10 would be inactive,” says Shah. “For example, they park money in public sector banks and do hedge transactions with a private sector or foreign bank.”
With the advent of foreign and private sector banks that aggressively offer trade-based products, companies are banking with them to leverage and enhance their financial supply chain. Dealing with multiple banking partners and platforms has added complexity to the treasurer’s functions.
Macroeconomic factors are pointing to increasing volatility, while complex global operations and regulatory requirements are leading to further challenges in cash management. Indian corporate treasurers need to redefine their strategies and equip themselves with the right skills and tools for risk management. With Modi’s focus on bringing in pro-business reforms, along with developing the domestic market, there is much optimism in the air. Corporate treasurers in the country need to be poised to enter this new phase.
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