Familiarity with a country’s payment system is a fundamental requirement when entering a new market. India has two options for domestic payments: in rupees (INR), while for amounts over INR2 lacs (around US$4,000) the real-time gross settlement (RTGS) system is usually used. For amounts less than this the National Electronic Fund Transfer (NEFT), which uses batch processing at a fixed time, is used.
India supports two types of cross-border payments, both of which use SWIFT messaging between banks as the primary communication channel:
- For inbound wires arriving in a foreign currency such as US dollars (USD) or euros (EUR), the bank in India converts the funds at its exchange rate, and deposits INR to the payee’s account. The corporate sender typically will not know the conversion rate applied, nor the final amount deposited to the payee’s account.
- For inbound cross-border wires, where the sender’s bank has converted base currency to INR, an agreed amount of INR is deposited to the payee’s account. The payer knows in advance the exchange rate applied by its bank, and can advise the payee of the amount to be received.
Foreign Exchange (FX) Market Dynamics
To operate effectively, multinational corporations (MNCs) need to be able to execute risk management strategies using foreign exchange (FX) spots, forwards and options. Spot USD-INR is fairly liquid with daily volumes of US$6bn and daily forwards volumes of US$4bn: most liquidity is found in tenors of up to two years, although the market quotes up to five years.
While there is an INR option market available, central bank guidelines prohibit corporates from being net sellers of options. However, companies can embed sold options in multi-leg cost reduction structures such as ‘seagulls’ or ‘collars’. Liquidity in the FX options market stands at about US$200m; it is quoted in tenures of up to five years but is most liquid in the up to one year range.
Indian companies and/or their subsidiaries typically have exposures in foreign currencies because they set their invoices, or are invoiced in, foreign currency terms such as USD or EUR, while their cost basis is in INR. This currency exposure can be hedged with an authorised dealer in India such as Bank of America Merrill Lynch (BoA Merrill) or other banks. If the Indian company wishes to avoid volatility and the need to create hedges, then they should work with their global partners to explore re-denominating their invoices to INR terms as this then shifts currency exposure to the global partner.
For a global company, hedging foreign currency in India may be more complex than corporate treasurers are used to in developed markets. Onshore hedges must not exceed the underlying exposure in terms of amount or tenure. To verify this, certified true copies of underlying bills and invoices must be submitted. As perfect hedges against defined exposures, onshore hedges qualify for hedge accounting and tax treatment.
Expanding Hedging Opportunities
While India’s hedging rules are strict, the central bank allows some flexibility in defining exposures; businesses that import or export can hedge using a past performance (PP) eligible limit calculation, which is the higher of either the previous year’s turnover or the average turnover in the last three years. However, PP limits have some restrictions and corporates should seek advice from experts.
Documentation requirements for hedging in India are relatively straightforward: a one-time completion of basic ‘know your company/customer (KYC)’ documentation along with the submission of documentation related to subsequent exposures that are being hedged are required. Given the potential benefits in terms of protection against volatility and improved predictability of revenue and payment streams, documentation requirements are not onerous.
Moreover, there are signs that hedging rules are evolving to MNCs’ benefit. The Indian central bank now allows non-residents such as parent companies of Indian subsidiaries or offshore entities doing business with Indian counterparties to hedge INR invoices. Trades must be in the name of the offshore entity and the authorised dealer in India and a request must be made to hedge INR exposure.
Many companies that expand into a new market invoice in USD or other home currencies in order to minimise complexity. However, there are significant advantages to invoicing in INR and, as a consequence, the practice is steadily increasing. Furthermore, this growth is being encouraged by the local regulator.
INR invoicing can benefit corporates by insulating their onshore subsidiaries and third party clients from exchange rate risk and external macro-economic turbulence. By eliminating FX risk, it can also help MNCs to increase their market reach, especially among small and medium-sized enterprises (SMEs) that may not be able to access foreign currency.
For MNCs, INR invoicing can enhance risk management by centralising it at a head office rather than at a subsidiary level. It can also prevent fluctuation of subsidiaries’ profit and loss (P&L). While there are drawbacks to invoicing in INR – for example it requires changes to internal accounting in enterprise resource planning (ERP) systems and needs agreement from counterparties – these are outweighed by the rewards in many cases.
Repatriation of funds invested in India and cash accumulation back to the parent company is restricted by regulations. The most common methods by which the MNCs repatriate the funds are:
- Dividend payouts subject to taxation implications.
- Share buybacks, which are also subject to some amount of capital gains tax.
- Royalty and payments of fees for technical knowhow, advance payments.
The Indian economy offers bright prospects for MNCs, with the country’s growth expected to accelerate in 2014 and some long-anticipated economic and market reforms are underway.
To fulfill their strategic objectives and minimise their FX and other risks, corporates need to work with a provider that has a deep knowledge of the Indian payments system and the intricacies of rupee invoicing and hedging. That way, they can take advantage of the opportunities available and are well-positioned to benefit further as regulatory and market changes open up new possibilities.
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