HOW A WEAK RUPEE AND FOREX LOSSES AFFECT YOUR STOCK ?

 COURTESY :ECONOMIC TIMES.

Last week, the Indian rupee touched an all-time low of Rs 57.32 against the dollar. While the Eurozone crisis is buoying the dollar, a combination of several domestic factors have weakened the rupee. In this quarter alone it has lost more than 12% against the dollar.

India Inc had got some relief when the rupee moved up from Rs 53.07/dollar to Rs 50.88/dollar in the fourth quarter of 2011-12. However, those gains have been wiped out completely because the depreciation in the April-June quarter (from Rs 50.88/dollar to Rs 57.16/dollar) has been far greater. So don't be surprised if several companies report forex related mark-to-market losses in the first quarter of 2012-13.

Differentiate between real and notional

Before you press the panic button, you need to understand how forex losses impact a company's bottom line. "Forex related losses have differing impact on different companies," says Dipen Shah, head of fundamental research, Kotak Securities. The forex losses reported by companies can be 'real' as well as 'notional'. Instead of clubbing all such losses under one head, you need to differentiate between the two.
Most of the companies that report forex related losses (and gains) are exporters who have taken positions in the forex market to hedge their future dollar earnings. For example, IT companies have forex related gains and losses in almost every quarter (depending on the rupee movement in that quarter).

While these exporters have to report mark-to-market losses in their hedging book in this quarter, this should not be treated as real losses. Why? Let us explain with an example.

Assume that an exporter has $100 million export earnings in a quarter and has hedged the full value at Rs 51 per dollar. Since the exporter can settle this transaction by giving delivery of goods, he is not making any real loss here. What he loses in hedging will be made up when he gets paid for the goods supplied.

However, this also means that the exporter will not get any additional benefit from the rupee depreciation. If he had not sold $100 million in the forward market at Rs 51 per dollar, he would have got Rs 57 per dollar. 

 "Exporters with hedged position will not be able to take advantage of the weakening rupee and, therefore, it is an opportunity loss," says K. Subramanyam, assistant vice-president, institutional clients, Asit C Mehta Investment Intermediates.

The situation remains more or less similar even if the exporter hedges the full year's export earnings. While one quarter's earnings can be settled by delivery, he will have to make provisions for the hedged positions of the remaining three quarters. The exporter will have to report it as a mark-to-market loss in his books.

However, the impact will only be temporary and he will benefit from the weakened rupee once the hedged positions expire. Also, if the rupee strengthens against the dollar in the coming quarters, those losses will become gains. But such mark-to market gains are also notional.

When losses are real

But this is not the case with companies that have foreign exchange liabilities-especially for companies that have not hedged their forex exposure or do not have a natural hedge in the form of export earnings.

"For exporters, it may be more like an opportunity loss, but for companies with un-hedged forex liabilities, it is a real loss," says Ambareesh Baliga, COO, Way2Wealth Securities. Some of these companies may try to avoid reporting it in this quarter's profit and loss account by capitalising and, thereby, directly taking it to the balance sheet. However, the loss still remains and they have to ultimately pay when these loans come for repayment.

The biggest impact of the rupee depreciation will be felt by companies that have taken foreign exchange loans during the last phase of the 2003-8 bull market. A large chunk of these loans are now due for conversion or redemption. More than $3 billion (Rs 17,150 crore) worth of foreign currency convertible bonds (FCCB) are coming up for redemption over the next three months . Since the stock prices of these companies are quoting well below the proposed conversion prices, the lenders may not opt to convert, but instead demand their money back. 

 Sectoral views

While the stock market has already punished the companies with un-hedged forex loans for this 'real loss', the market was not willing to reward the exporters. Even though the rupee depreciation benefits them, not all exporting companies have witnessed a big rally. There are several reasons for this.

First, export sectors like textiles are already facing a severe demand contraction and therefore, good performance can come only from more stable sectors like IT or pharma. Second, the exporters with hedged positions are not able to reap the entire benefit of rupee depreciation.

"Among the leading IT players, Infosys has the least hedged positions and therefore, will be able to benefit most from the current rupee depreciation," says Subramanyam. Third, the customers are also aware of the depreciation in the rupee and therefore, demand a part of the profit in the form of lower prices.

"A weak global environment and a weakening rupee can encourage clients to ask for billing rate cuts," says Ankur Rudra, sector lead, Ambit Capital.

Only the pharma sector is in a position to reap the maximum benefit from the fall in the rupee. The sector caters to the basic needs and its global demand is quite stable.

 
 

India Inc's MTM losses may worsen next year if rules are not changed

Courtesy : ET


Few things in recent times have foxed companies and rattled investors like the mark-to-market (MTM) losses caused by a surging dollar.

Businesses of all kinds are grappling with the phenomenon and looking for ways to soften the blow. Some were caught on the wrong side of the currency movement, with their forex loans bloating in rupee terms while for others, profits dipped even after taking a forward cover - an instrument that is meant to shield them from exchange rate swings.

Indeed, MTM losses on foreign loans will multiply from next year if book-keeping rules are not changed and the rupee fails to recover. On one hand, discussions are underway to make accounting rules more realistic and allow companies to spread out MTM losses on foreign loans in the coming years; on the other hand, many companies are slowly discovering the maze of hedge accounting - a subject that few CFOs took the trouble to grasp, but a complex process that can lower MTM losses.

The flexibility that companies have in amortising losses on foreign loans will end in March. At present, a 10-crore MTM loss on a five-year loan can be absorbed at 2 crore every year over the life of the loan - a practice that cushions the bottom line. If rules are not changed, then from next financial year, the remaining loss (of 8 crore) has to be booked at one go, which can severely impact profitability.

The Accounting Standards Board, a body of senior professionals that initiate changes in accounting norms, is taking a close look at the matter, along with another accounting treatment that artificially inflates fixed assets.

"We should come out with a clear rule so that MTM losses on loans don't have to be provided in one quarter in the times to come. This will lower panic and volatility," said S Santhanakrishnan, a senior chartered account and member of the board.

In preparing balance sheets, companies match the higher loan liability by increasing the value of fixed assets, which many feel is misleading, particularly to lenders, and should be corrected. "If your loan goes up by 10 crore, is there any justification for raising the value of your asset which was financed with the loan? ", said Santhanakrishnan. Perhaps, a more prudent way would be to lower a company's reserves in balancing a higher loan liability.

According to G Ramaswamy, president, The Institute of Chartered Accountants of India (ICAI), the issues are being debated. "No decision has been reached. This has also assumed significance because several companies have booked MTM losses." So far, 12 Nifty companies have booked 3,120 crore MTM losses this quarter against a gain of 2,225 crore in the year-ago period.

HOW MTM LOSSES ARISE

With the dollar at 50, there will be 10-crore MTM loss on an unhedged $10-million foreign loan taken when dollar was 40. Here are other cases where MTM losses can crop up:

1) A company entering into a forward contract in early August with a bank to sell its export receivables (that's expected in December) will have to book an MTM loss when it announces the results for September 30. If the rupee has dipped 4 between August and September 30, the MTM loss is 4 for every dollar as on September 30.

But this is a notional loss that reflects a lost opportunity for the company to sell at a more lucrative exchange rate. Even though there is no real hit, stock prices fall as soon as results are announced. But a company is not required to show the MTM loss if it pursues hedge accounting which only some large companies have adopted.

"One reason for this is the level of complexity involved and the awareness. Although hedge accounting can be complex, for simple transactions (like sale of export receivables), it can be simplified and implemented on a larger scale," feels Kumar Dasgupta, partner, Price Waterhouse.

2) Companies that have swapped their expensive rupee loans into cheaper dollar loans through currency derivative deals also lose out badly when dollar gains. In a sharp depreciation, the loss on account of a stronger dollar can more than offset the savings in interest outgo. There is MTM loss on the derivative (like the forward contract) at the quarter end.

3) Since commodity prices are closely linked to global prices, commodity companies often pursue a different strategy. For them, a rise in dollar (say, from 40 to 50) is actually a gain: if the global price is $700 a tonne, then the local price rises from 2,800 to 3,500 a tonne.

But many of these companies swap their rupee loans into dollars to offset the loss from a weakening dollar. They book MTM loss on the loan swap derivative. Also, when dollar appreciates sharply, the local price of the commodity corrects only after a month or two.