Emerging Trends in FX Risk Management in India

The Indian rupee, like many other Asian currencies, has seen large two-way movements in the past two or three years, ranging between 8% and 33%. As normally happens in most markets, many companies have been caught selling at the lows and buying at the highs. Corporate India has not been used to this kind of volatility. Adding to the angst, the Reserve Bank of India (RBI), which traditionally used to be a regular participant in the dollar-rupee market, has stopped intervening over the past six months. Companies are reconciling themselves to the fact that volatility is here to stay – it cannot be wished away. An increasing number of companies are now trying to learn how to deal with the situation.

Welcome Trends

Greater awareness

Firstly, the large two-way movements have put importers and exporters, buyers and sellers on their toes. There is greater awareness of currency risk on both sides and greater anxiety as well. Not surprisingly, of course, the old emotions of fear and greed remain as potent as ever, especially at the major trend reversal points. For instance, when the dollar-rupee touched a low near 44.19 in April 2010, the importer was certain of a fall to 42, and so was the exporter. Importantly, though, more companies are keen on hedging now compared to, for example, five years ago. This is a very encouraging trend.

The introduction of, and burgeoning volumes in, the exchange-traded dollar-rupee futures market has also greatly aided the awareness and interest in hedging.

Better management by smaller companies

Secondly, smaller owner-driven companies, in contrast with larger board driven companies, seem to be more proactive and willing to tackle FX risk management in a holistic, systematic manner, rather than on an ad-hoc basis. Not having to ‘manage by committee’ obviously works in their favour. Also, it is to their advantage that, as they have been traditionally under-serviced by the banks, they are more likely to be open to fresh ideas and new ways of managing risk.

Maximum one year

At the height of rupee bullishness in early 2008, when the dollar-rupee exchange rate was near 39.50 and the consensus view was of a further fall towards 38-36-35, it was fashionable for companies to enter into hedges spanning five, or even seven, years. Exporters were seen selling their entire proceeds for the next few years through exotic leveraged options. But then, as the rupee depreciated 33% to 52, several of these long-term hedges went deep out-of-the money. Often, it was found that many of these hedges were not mandated by standing, board-approved hedging policies. Chastised and with lessons learnt, companies are now generally restricting their hedge maturities, especially on revenue exposures, to 12 months at the most.

Our research tells us that forecasting error for periods beyond 12 months can exceed 10%. Essentially, therefore, anyone forecasting beyond 12 months is likely to be shooting in the dark and has equal chances of being spectacularly right and embarrassingly wrong. As such, the fact that people are now restricting their hedges to 12 months is a very welcome development, in keeping with prudent risk management practices.

Simple, and no leverage

Leverage has become a bit of a dirty word among corporate hedgers in India. People are shying away from the once highly popular 1×2 and 1×4 put risk reversals, range forwards, accumulators and kiko options that actually ended up increasing risk for the companies rather than protecting them against risk. Instead, companies are now looking to use either plain forwards, or plain vanilla options, or at the most simple 1×1 range forwards or risk reversals. This is good news for the corporates, but not such good news for the banks that were selling these hedging products.

Not banking on banks alone

Corporate India is now increasingly willing to pay for professional advice separately, in addition to the advice it receives gratis from banks that provide it with transactional services. There has been a healthy growth in the past 12 months in the number of individuals and firms providing currency forecasts and hedging advice to corporate India. Increased competition is leading to an increase in quality levels all around. This is a very welcome emerging trend for the Indian FX market.

All in all, the past 12-15 months has brought about an increased awareness and maturity about FX risk and its management in corporate India.

Still a Long Way to Go

However, as always happens with progress, there is still a lot of ground to be covered. For instance, greater awareness is still to come about in the following areas:

Still no concept of hedging cost budget

None of the companies we work with had even heard about a hedging cost budget before we came into the picture. Hedging is as much a business activity as any other and a budget needs to be allocated for it. Two important items to be included in a hedging cost budget are option premia and losses on out-of-money hedges. Apart from this, incidental running costs like information systems subscription charges, derivative pricing systems, revaluation services and salaries should be included in a hedging cost budget.

Still prefer ‘zero cost’ structures

Because there is no concept of a hedging cost budget, companies still prefer ‘zero cost’ option structures, as opposed to simple, plain vanilla options where the premium is paid upfront. This is despite an implicit acknowledgement that ‘zero cost’ options are not really costless, because they actually provide much less risk coverage than plain vanilla options. There is enough research to show that plain vanilla options tend to be more effective, in terms of both costs and benefits, than zero-cost options. Yet there is a huge preference for zero-cost options.

There is an urgent need at the board level in companies for an appreciation of the urgent need for a hedging cost budget. Companies are unknowingly doing themselves a disservice.

Hedges still overshadow exposures

Most companies still think of a hedge as a ‘position’ they have taken in the market. They do not see their exports and imports as intrinsic market ‘positions’ that they have to either protect or close out at the earliest opportunity. The profit/loss on a hedge is accorded much more importance than the profit/loss on an underlying export/import. Management wants to see hedges generate profits, forgetting that when a hedge makes money, the underlying exposure is actually losing money. If a risk manager takes a conscious decision to leave an exposure unhedged because he sees that an ongoing market trend is favouring the unhedged exposure as it is, management is seldom willing to give him credit for his vision and foresight.

There are several reasons for this anomaly. The biggest is that hedges are marked-to-market for accounting and reporting purposes. Exposures are not usually required to be marked-to-market. The second reason is that people think they can get in and get out of a number of ‘trades’ before an exposure matures and contribute to the cash flows of the company.

Still wedded to the ‘natural hedge’ concept

Even though there is agreement that the concept of ‘natural hedge’ exists only in theory, rarely in reality, many companies still abide by this concept in their FX risk management policies. Companies may do well to look at a different hedging paradigm, because it is possible to earn a positive differential between the rates paid on imports and the rates realised on exports, even if a natural hedge does exist. This can lead to a riskless increase in corporate profitability.

Still looking for a practicable hedging policy and strategy that works

In the aftermath of the volatility seen and lessons learnt over the past couple of years, many companies are feeling that their old FX risk management policies are not serving them well and are looking around for, and testing, policies that may be more practical and effective in dealing with FX risk. This, in itself, has to be a good thing.


The past two years have forced companies to look at FX risk management more closely. There is a process of churn and introspection underway, which can only lead to greater maturity in a market that has already matured substantially over the years.


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