The Chicken and Master
Story*
A chicken
is fed every day by its master. At precise times of the day, the master’s wife
comes and feeds the chicken. Relishing its daily food smugly, the chicken in
its mind establishes a link between the approach of the master’s wife and feed
being put into its bowl. The chicken forms an impression that whenever the
master’s wife comes, she brings fodder.
Like every
story, there’s a twist in the tale.
Finally,
the chicken’s run of good luck comes to an end. You may have thought the
chicken doesn’t get its food one day. No, on one fateful morning the farmer’s
wife comes over and wrings the chicken’s neck.
Yuck,
this is really loathsome! Well, that’s how some stories end. In the real world
too.
(*
This is a favourite story of Bertrand Russell, British
philosopher and mathematician of great repute. Source: Sophie’s World by
Jostein Gaarder.)
Foreign Exchange Losses
As in the
above story, Indian corporate managers have often been fooled by the movement of
dollar-rupee currency exchange rate. They made equity investors shaken once
again.
The
Indian rupee moved between 44.50 and 50.00 during the second quarter of this
fiscal year. Prior to this period, the rupee’s exchange rate was stable for
about 18 months. So, the finance managers believed that the rupee would remain
stable against major currencies, like, dollar, sterling, euro and yen. They
formed a general link between the past stability and future movement of
dollar-rupee rate.
Rama Krishna Vadlamudi,
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They were
proved utterly wrong when the US dollar appreciated against the euro, etc.; and
the rupee lost about 10 per cent versus the dollar. They could have saved the blushes for
stakeholders had they taken appropriate hedging strategies. The finance
managers smugly assumed that the rupee would remain in a small range and failed
to hedge their forex positions, which cost the companies heavily.
The
amount of losses Indian companies are suffering on their foreign exchange
exposure makes us wonder what kind of risk management practices they are
following to minimize their foreign exchange losses.
There is
no doubt whatsoever that India Inc’s understanding of foreign exchange risk is
rather primitive. In 2007 and 2008, Indian companies made heavy losses due to
unexpected appreciation of rupee against the dollar. At that time, companies
assumed that the Reserve Bank of India
Time and
again, Indian companies are unable to measure the exchange rate risk and take
appropriate steps to reduce the risk. Maybe, they are playing with stakeholders’
funds in an overconfident way in the foreign exchange market.
Forex
losses are on account of exchange rate fluctuations and derivatives
transactions involving imports, exports, expenses and foreign currency
borrowings.
List of a few companies
Greenply
Industries: The company made a forex loss of Rs 11.2 croe and a net profit of
Rs 11.9 crore during the quarter ended September 2011. As can be seen from the
table below, the company would have doubled its profit but for the forex loss.
Interestingly, the company made forex losses in June 2011 and September 2010
quarters also amounting to Rs 4.68 crore and Rs 6.48 crore respectively.
Not only
small companies, but big companies too are making forex losses.
Bharti
Airtel: During July-September 2011 quarter, forex loss was Rs 239 crore versus forex
gain of Rs 249 crore during July-September 2010 quarter.
Sterlite
Industries: The company suffered a total forex loss of Rs 466 crore during the
second quarter on account of mark-to-market forex losses arising out of foreign
borrowings, consumption of raw materials and other expenditure.
Interestingly,
these companies have revealed (on their websites and on the stock exchanges’
websites) very sketchy details about the nature of these forex losses.
Below is
a random list of companies which suffered losses on account of rupee’s 10-per
cent fall against the US dollar during the July-September 2011 quarter:
Company
|
Foreign Exchange loss
|
Net Profit
|
Rs crore
|
Rs crore
|
|
Exide
Industries
|
15.0
|
51.0
|
Srei
Infrastructure
|
39.0
|
25.0
|
Bajaj
Auto
|
95.0
|
726.0
|
Bharti
Airtel
|
239.0
|
1,027.0
|
Dish TV
|
30.0
|
(49.0)
|
JSW Steel
|
513.0
|
127.0
|
Blue Star
Ltd
|
19.5
|
(20.8)
|
Essar Oil
|
407.0
|
(166.0)
|
Greenply
Industries
|
11.2
|
10.1
|
Sterlite
Industries
|
466.0
|
1,744.0
|
Figures
is brackets are net losses
Jawaharlal Nehru, independent India ’s
first prime minister, believed that the Chinese were very friendly and rubbed
shoulders with Zhou Enlai; and ultimately we paid a very heavy price when China
Likewise,
we thought stock prices of real estate companies would go up forever as real
estate prices had been rising for long. Real estate companies have been suffering
in the last three/four years even as real estate prices have remained stagnant
or slightly gone up.
We are
pattern-seeking animals. Ancient men observed that the Sun rises in the East
and sets in the West. The observation made them to assume that the Sun was
going round the Earth until Copernicus discovered that it was the Earth that
was going round the Sun.
We are
often fooled by patterns in nature and society. We assume what we observed in
the past will continue in future also. In the real world, it does not happen. Mostly,
historical patterns have a way of not repeating themselves in future.
The
financial managers of companies need to have a proper understanding of
financial history. They have to expect the unexpected and devise some hedging
strategies to protect shareholders’ wealth. Otherwise, we will continue to
suffer due to the excesses of these people.
- - -
For author’s latest articles on dollar-rupee movements, just
click:
Note on author: Author is an investment analyst
and writer. The views are personal and this is written only for information
purpose. The author has a vested interest in the stock markets. Readers are
advised to consult their certified financial adviser before taking any
investment decisions.
Author’s articles on financial articles can
be accessed at:
This is a comment received from Mr R Janakiraman, an expert on foreign exchange:
ReplyDeleteDear Ramakrishna,
Interesting article. But the articles assumes that all these companies made these losses in forex due their failure to hedge their exposures. I do not subscribe to this view. In my view, most of the losses are NOT due to the non-hedging but due to ACTUAL HEDGING by the companies. It may sound strange but it is true.
According to accounting policieis, all the forward contracts of comapanies have to be valued at present cost (that is, cost at which they can be cancelled/squared). After seeing Rupee at around 44-45 for long, most of these companies would have booked forward contracts (selling their future receivables) when Rupee went above 45 and 46 levels. Little would they have thought that Rupee would go above 49 and even cross the 50 mark. All those forward contracts that they booked at 45 and 46 levels have to be revalued at present levels and the forex losses have to be shown. That is the reason for all these forex losses - in most cases. Had they not hedged and kept their exposures open, I am sure most of the companies would not be showing any forex losses.
Regards,
R. Janakiraman
Dear Sri Janakiraman,
ReplyDeleteI’m very grateful to you for valuable opinion on my article on forex losses written a month back. I agree with your opinion that hedging by Indian exporters results in notional forex loss as Indian rupee has sharply depreciated against the US dollar. (As soon as I received your mail, I posted your comments on my blog so that all the readers would be benefited by your valuable views).
Last month, I happened to glance at the books of some exporters in Vizag. Their books were showing notional forex losses as they booked forward contracts for the dollar receivables which are due in the next one year. As the rupee starting falling from 45 to 48 and beyond, at every level they were booking forward contracts with their bankers. When I saw their books, the rupee was around 50 and still their books were showing notional losses, despite booking forward contracts.
Regarding my article, it was not my intention to create the impression that hedging was a panacea for avoiding forex losses. Hedging only helps companies in reducing unexpected future losses.
To help the readers of my blog understand the topic in a better manner, I’m posting this reply also on my blog.
Having said that, I’d like to add a few points. TCS Limited, a net forex earner, had recognized a forex loss of Rs 97 in its Profit and Loss account during the Jul-Sept 2011 quarter. It seems TCS hedges 80 per cent of its forex receivables against 40 per cent by Infosys. During the last quarter, net forex earner making a forex loss is a rare case.
In contrast, most of the net forex spenders have reported very large forex losses. These net forex spenders were carrying debts (ECBs or FCCBs) denominated in foreign currencies or resorting to big imports of machinery or raw materials. These debtors/importers took a big bet on the currency and kept their forex positions open suffering huge losses in the process. Simply put, the companies’ speculation on the exchange rate has backfired as they left their forex loans or forex spending unhedged to save on hedging costs. In the process, such companies paid a heavy price when rupee depreciated sharply against major currencies. My article was against such unbridled speculation by net forex spenders. What irked me to write strongly against their poor risk management practices was that the recent losses were a repeat of what India Inc suffered during 2007/2008. Some companies don’t learn from their past mistakes.
Once again, I thank you immensely for your time and clarification.
With regards,
Rama Krishna V
PS: I was travelling a bit last month – hence this delayed reply