Foreign exchange volatility and Hedging.

Forex Hedging in India

Hedging for Exporters Vs Importers
Forex is easy to hedge for forex receivers that is exporters.
They can buy a put for the spot price at less than a rupee per dollar hedged.
So they can lock in floor price at very cheap rate and keep the upside open.

There are practically no easy options for importers who needs to pay in dollars.
The calls cost around 5 to 6 rupees for every dollar hedged for one year tenure.The forward premium is around Rs 5.So unless one fears that the fluctuation will be beyond that amount there is no point in covering.
The best course of action is to look for natural hedge like matching dollar inflows and outflows or some other ways.

Forex hedging for contingent exposure risks

Forex Hedging in India is allowable on need based.
However RBI allows Forex earners to hedge the contingent exposures expected to arise out of bids which a company may  or may not win. The products allowed for contingent exposure are only options and not forwards. Now RBI does not allow selling calls and collecting premium. So the only avenue allowed in such cases are buying a put.

Commodity Hedging in India

Regualtion of commodity markets in india

  • Commodity hedging in need based
  • The authorised dealer who handles the account through which commodity trades are routed needs to ensure commodity exposure is within limits.
  • The commodity need correlation can be indirect.

For example for companies importing switchgear silver is a major component. Hence they can buy silver hedge options.

Typiall RBI take a month to clear the application for indulging in commodity trading/hedging.
Whereas in forex it only takes a week to give permission

RBI’s steps to curb forex market volatility in 2013

July 8 2013
  • Banks barred from proprietary trading in currency futures and exchange-traded options
  • Lenders allowed to trade only on behalf of clients
July 15 2013
  • Borrowings under LAF capped at ~75,000 crore
  • The lending rate for MSF fixed 300 basis points above repo rate, at 10.5%
  • Open-market sale of bonds worth ~12,000 crore
July 22 2013
  • LAF borrowing cap further tightened to 0.5% of each bank’s deposits
  • Banks must keep daily CRR balance of 99% of requirement

Deatails of July 22 steps

Exactly a week after tightening liquidity to stabilise the volatility of the rupee, the Reserve Bank of India (RBI) on Tuesday imposed new restrictions on commercial banks’ access to cash.

Experts said call rates and bond yields would rise sharply as a result of the RBI action. “The impact of the steps will have significant impact on banks. Both call rates and bond yields will increase sharply,” said Andhra Bank Chairman and Managing Director B Prabhakar.

The rupee, which has been one of Asia’s worst-performing currencies this year and has fallen 10 per cent against the dollar since the start of May, on Tuesday closed slightly weaker at 59.76 a dollar.

In a statement, RBI said banks would be permitted to borrow under the liquidity adjustment facility (LAF) only up to 0.5 per cent (lowered from one per cent) of their net deposits and time liabilities at the benchmark interest rate of 7.25 per cent.

Additionally, RBI has tightened rules on the cash reserve ratio (CRR), or the percentage of deposits banks must keep in cash with the central bank. Now, banks will have to hold cash equivalent of at least 99 per cent of CRR on a daily basis, compared with 70 per cent earlier. While the LAF borrowing norms will be effective immediately, the stipulation on CRR will take effect from next fortnight.

RBI has not lowered the aggregate borrowing cap of Rs 75,000 crore through LAF that it had set last Monday in its first round of liquidity-tightening measures. In effect, however, banks’ LAF borrowings will be reduced by half. If banks want more funds, they will have to borrow from the marginal standing facility (MSF), under which interest is charged at higher rate of 10.25 per cent.

“Effectively, the repo rate becomes the marginal standing facility rate, and we have to adjust to this new rate regime. The steps show the central bank wants to stabilise the rupee,” said SBI Chairman Pratip Chaudhuri.

Business Standard

RBI is not doing enough to defend the falling rupee

When the rupee hit a record low on July 8 2013, the RBI withdrew cash from money markets, making bets against the currency significantly more expensive.
It intervened to stop the currency from dropping beyond 60 per dollar and at the same time tried to assure investors the shock measures were temporary.
To most RBI watchers, this amounted to a menu of stop-gap measures that failed to account for lasting pressure on the currency. To the central bank, it was doing enough to support the rupee without tightening cash conditions so much that it threatened the longer-term growth of an already weak economy.
The eye on growth means it has avoided following its emerging market peers Indonesia, Turkey and Brazil, who all raised their policy rates in anticipation of a long spell of capital outflows as the United States prepares to tighten policy.
It is unlikely to raise rates either on Tuesday 30th July 2013, when it reviews policy, even though analysts argue it should do so if it wants to signal its determination to attract foreign funds and defend the currency.
History suggests these decisions are deliberate and ultimately growth is the overriding factor.
The rupee has fallen 33 per cent against the dollar since 2007. As recently as 2010, the RBI's reluctance to raise interest rates for fear of affecting growth allowed inflation to remain at near double-digit levels for two years.
"The right approach would have been to move the official policy levers," said Rajeev Malik, senior economist at CLSA in Singapore.
Malik feels the central bank might be hoping a temporary tightening of money markets will stabilise the rupee. And that the RBI is either too optimistic or it is wary of announcing a turn in monetary policy.
"Ultimately, at least how I see global liquidity developing, it will be a lose-lose proposition," he said. "India will suffer a GDP downgrade and the rupee will also break 60 in a sustained manner. They have boxed themselves into a corner."
To be fair to the central bank, the country's balance of payments problems are beyond its control.
India has historically been a capital-starved economy, with imports and foreign debt servicing bills that far exceed revenues. Capricious governments have done little to ensure a steady stream of foreign investment flows, and India remains one of the most difficult countries in which to do business.
No wonder, critics say, that the current account deficit has blown out to a record 4.8 per cent of gross domestic product, or about $88 billion, in an economy whose growth has slowed to a decade low of 5 per cent and where consumer inflation is nearly 10 per cent.
Collateral Damage
"Yes, exchange rate stability is the focus now in the short-term," said a central bank official, declining to be named as he was not authorised to speak to the media. "But that is because, in the long-term, we want to protect growth for which we have to focus on the exchange rate in the short-term."
That view point was backed up by India's chief economic adviser, Raghuram Rajan, who told a television channel on Thursday that policy measures were geared to stabilising the currency with "minimal damage" to growth.
Tasked with controlling inflation, keeping the economy growing and ensuring financial stability, plus the pressure of pleasing its political masters, it is often of no surprise that the RBI makes growth a priority.
Even though rates were raised 13 times between 2009 and 2011, economists often felt the RBI was behind the curve and allowed prices to stay too high for too long.
Likewise, while the RBI raised rates to defend the rupee during periods of turmoil in 1998, 2000, 2008 and 2011, the policy tightening was often quickly reversed within two to six months, analysts said.
This time, the central bank is in more of a bind than normal. With currency reserves falling rapidly - at $280 billion they cover just 7 months of imports - and external debt worth $172 billion, a fast-slipping currency could eventually risk financial stability.
Yet, raising its 7.25 per cent overnight repo rate would be politically difficult as the ruling coalition has to call a general election by May.
"Policymakers are trying to achieve a fine balance by squeezing liquidity at the short-end even as they try to cap yields at the long-end," JPMorgan Chase said in a client note. "Yet, some transmission to long rates, funding costs and investment decisions is inevitable."
The RBI's decision to raise its short-term emergency funding rate by 300 basis points has already driven 10-year government bond yields up 100 basis points and short-term corporate debt up 200 basis points across the board.
It is inevitable that growth and therefore foreign inflows into the equity market will be adversely affected, JPMorgan said.
While the RBI has not explicitly said so, its actions suggest 60-per-dollar is a line in the sand for the exchange rate. Analysts think that is a mistake.
An inability to defend that would hurt market confidence, yet a dogged battle for the level could mean the central bank compromises stability in other parts of the economy, particularly by increasing volatility in money markets.
"Stability in the rupee is what will constitute victory," said Sanjay Mathur, RBS economist based in Singapore. "That may even take a few months and the RBI may be ready for that haul."
Analysts expect stability to mean less volatility in the currency rather than a turnaround and the indications are that the central bank has not won the battle yet. Market expectations of future one-month rupee volatility are still 4 percentage points above the 7 per cent levels of May.
For now, economists expect the central bank to do more of the same: discreet policy tightening through its web of open market operations.
They expect other non-monetary administrative options, such as forcing exporters to bring earnings home quickly or forcing oil importers to stagger their bulky dollar payments, if the pressure is sustained. The government is, meanwhile, examining ways to raise money from non-resident Indians.
"To reverse these measures, the RBI might need to conclude that these steps were ineffective or the costs entailed were too high or the external environment has to improve markedly," said Radhika Rao, economist at DBS in Singapore.
"We don't believe either of these will pan out in the short-term."

Capital controls on resident individuals and companies leads to plausible, eventhough not actaully probable, fear of capital controls on non-residents

The Indian rupee fell to a record low on Friday as central bank measures to tighten capital outflows and curb gold imports were seen as unlikely to prop up the currency and could even spark further selling if they spook foreign investors.
The rupee hit an all-time low of 62.03 to the dollar, breaching its previous record low of 61.80 hit on Aug. 6.
India late on Wednesday restricted how much its citizens and companies can invest abroad to reduce pressure on the rupee, while targeting the current account deficit by banning imports of gold coins and medallions among other measures.
The efficacy of the steps remains in doubt, given outflows have already been declining this year and that they ultimately do not address the need to attract overseas investments to narrow a current account deficit that hit a record 4.8 percent of gross domestic product in the year ended in March.
Instead, traders fear the capital restrictions could adversely impact company profits and could lead to stronger capital restrictions that would scare off foreign investors at a time when the expected tapering of U.S. monetary stimulus is already creating uncertainty in emerging markets.
"The steps taken so far only target residents, but if this raises expectations that they could potentially resort to capital controls targeted at non-residents, that could have adverse near-term implications for capital flows," HSBC's Chief economist for India and ASEAN Leif Eskesen said.
"It will, therefore, be critical to tread very carefully when it comes to capital controls, to anchor expectations, and also not use it as a substitute for more appropriate and effective measures," Eskesen said in a note to clients.
The partially convertible rupee was trading at 61.88 per dollar at 1031 India time (0501 GMT), weaker than its Wednesday's close of 61.43/44.
One-month offshore non-deliverable forwards were quoted at 62.46, weaker than the onshore one-month forward of 62.35.
Indian financial markets were closed on Thursday for a national holiday.
A Reuters poll issued on Thursday showed short positions in the Indian rupee have hit the highest in two months amid sustained doubts over policymakers' ability to stabilise the currency.
The weakness on Friday also reflected a firmer dollar in Asia amid uncertainty about the U.S. Federal Reserve's stimulus withdrawal after upbeat U.S. jobless claims data on Thursday suggested an early end to the Federal Reserve's asset purchases.
The benchmark 10-year bond yield surged 16 basis points to 8.66 percent from its previous close after U.S. Treasury yields jumped to two-year highs.
Measures to restrict capital outflows come as overseas investments from India had already been on the wane, averaging a monthly $400 million in the first half of the year from $710 million in 2012, according to DBS data.
To prop up the rupee in the near-term, markets would need assurances that India can attract foreign flows in an increasingly difficult global environment.
Foreign investors have sold a net $11.6 billion of Indian debt and equities since late May.
India last month unveiled plans to further ease restrictions on foreign direct investment (FDI) in sectors such as telecoms and defence.
Although the government hopes its latest reforms attract long term capital flows, previous measures have had mixed results. FDI fell to $36.9 billion in the fiscal year ending in March from $46.6 billion the previous year.
The RBI on Wednesday also eased some of the rate limits for deposits targeted at non-resident Indians (NRIs), though that is also seen as unlikely to attract inflows in the near term given that NRI deposits have seen net withdrawals of $1.1 billion in May and June, according to DBS.

Top 5 Pros and Cons of a weak rupee
A look at who gains and who loses due to a weak rupee

Pros of a weak rupee
1. The obvious benefit is to the exporter, which in turn would revive economic growth. Textile sector is among the first off the block. The sector has witnessed strong growth which is reflected in the numbers disclosed by the ministry. In fact, the ministry has revised its export target by 20%. The sector is now facing a problem of plenty. Unable to get labour, the textile ministry has asked the government to link it with MNERGA.
2. Foreign investment both through the secondary market and direct investment into sectors which are relatively sheltered from a weak currency can yield better returns over the long run. A stronger dollar would give the investor more rupees in his hand and thus an opportunity to buy more shares.
3. Though India does not attract the massage seekers, a weak currency can make the destination attractive for in-bound traffic. Medical tourism can get a shot in the arm.
4. A number of Indian companies now have sizeable international presence apart from direct exports. A stronger foreign currency helps boost their consolidated numbers.
5. Import substitutable products get an indirect shelter on account of a weak currency. Metals, especially steel was affected by imports from other Asian countries, but a weak rupee has increased the landed price of these products. A number of sectors and companies that price their products on import parity basis will benefit. 
Cons of a weak currency
1. India imports key inputs like oil which is the fuel for its growth. Rising imports will increase the current account deficit.
2. A weak rupee imports inflation as it increases the cost of imported goods. This will further reduce RBI's ability to lower key policy rates.
3. Students looking to study abroad are severely hit as they have to shell out more rupees to meet the cost.
4. Certain sectors which are dependent on imports become uncompetitive. With government discouraging imports of non-essential goods like Gold, a weak rupee can lead to rising unemployment.
5. It affects those companies who have raised debt abroad and have not fully-hedged their position.