As India grapples with a falling rupee, some companies are likely to be hit much harder than others. Nandini Lakshman reports from Mumbai
For some time now, the falling rupee has been making life miserable for corporate India. On 21 August, a week after India celebrated its 67th Independence Day, the rupee fell to a record low of ₹64.11 to the US dollar, a 16% decline since May. Two years ago it was ₹45.35 to the dollar. Other Asian currencies have also followed the rupee’s slide on speculation that the US Federal Reserve would scale back stimulus.
Experts attribute the pummelling that the Indian rupee has been receiving to a host of reasons. They include the widening of the current account deficit, high inflation, slackening growth, rising external commercial borrowings (ECBs) and increasing imports of fertilizers, coal, crude oil and gold. The pandemonium caused by the falling rupee is nowhere close to abating.
“The rapid depreciation of the rupee put us in a vicious spiral,” said D Subbarao, the governor of the Reserve Bank of India (RBI), speaking to the media in late July.
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“It will hurt Indian businesses, which have high levels of foreign debt in their books, but lack proper hedging tools to offset the risk,” Crisil, the Indian arm of global credit rating agency Standard & Poor’s, reported in July.
Hedging regrets
Indian companies have reportedly raised ECBs and foreign currency convertible bonds (FCCBs) to the tune of US$4.7 billion. These amounts are expected to mature over the next five years, beginning in 2014, and will need to be repaid in dollars at the prevailing exchange rate.
“Most of the FCCB bond holders have dollar-denominated loans ranging from five to 10 years, and many haven’t hedged their currency,” says Karan Singh, a Mumbai-based partner at Trilegal who heads the firm’s banking and finance practice.
As such, companies will be seeking a way out. However, pointing out that the RBI is doing what it can and companies have to follow, Singh says: “They can’t do anything legally as these are commercial transactions.”
However, as Freddy Daruwala, a Mumbai-based partner at Nasikwala Law Office, points out, “the financial implications may have legal repercussions if the government changes tax laws to give exports a boost, or if borrowers default on payments”.
Companies that are seeking opportunities overseas will be actively hedging against future depreciations by entering into forward contracts to purchase dollars at a predetermined rate at a future date. This will guard against a further fall in the rupee, but any potential gains made through rises in the rupee will need to be forgone.
“Those who have foreign currency income streams would find it less of a challenge to complete deals overseas,” says L Viswanathan, a Mumbai-based partner at Amarchand Mangaldas and head of the firm’s project finance team. “Companies with primarily rupee resources may have to provide more collateral.”
Each to his own
The impact on companies is likely to vary across sectors. Indeed, market experts explain that companies within a sector will be affected differently, as each company’s product mix, hedging position, and the markets it operates in will all make a difference. For instance, if an Indian company has a robust business within India and a substantial presence in Africa, Latin America and Russia, the advantage it has gained will be negated, as the US dollar has appreciated against most of the currencies in those markets as well.
The oil and gas sector provides evidence of how a weak rupee impacts different companies. Entities that market oil and natural gas, such as Reliance Industries, which is part of one of India’s largest corporate groups, and state-owned Oil and Natural Gas Corporation (ONGC), are expected to notch up profits on the back of a depreciated rupee. Reliance gains from the rupee depreciation as it imports crude oil and exports value-added products. ONGC benefits because in 2010 the Ministry of Petroleum and Natural Gas changed the currency for the pricing of natural gas produced in India from the rupee to the US dollar.
At the same time, public sector monoliths such as Hindustan Petroleum, Indian Oil and Bharat Petroleum import almost 70% of the nation’s crude oil requirements and sell their products in India at government-subsidized rates.
These companies are extremely vulnerable to volatility in the rupee as they rely on foreign currency that is largely not hedged.
Hedging strategies key
Companies in the pharmaceuticals sector stand to gain from a depreciating rupee. Exports account for more than half of the revenues from the sector, as India’s pharmaceutical companies have a substantial global presence. However, even within the pharmaceutical sector, a lot depends on the hedging strategies of individual companies.
Both Cipla and Sun Pharma have reportedly left a large portion of their revenues unhedged, allowing them to reap the benefits of the weak rupee. But Dr Reddy’s Laboratory and Ranbaxy are reported to have hedged their cash flows at lower exchange rates, thus missing the opportunity provided by a falling rupee.
Tough times
Rating agency Crisil says that the effect of a weak rupee, coming at a time of sluggish demand, will push input costs up across several sectors.
This could prove difficult for the auto sector which already faces rising fuel costs, high interest rates and dwindling consumer demand. According to the Society of Indian Automobile Manufacturers, demand has now fallen for nine straight months. Fuel costs account for more than 25% of the ownership costs for small cars, which make up the bulk of auto sales in India.
International automakers, whose locally made vehicles have high import content, are equally concerned. Speaking in June at the launch of the Mercedes E class car in Hyderabad in southern India, Eberhard Kern, the managing director of Mercedes-Benz India, said: “This is quite concerning. As a corporate, we have a global hedging policy in place.” He added that there was a threshold for such hedging, which was not sustainable due to the steep fall in the rupee, and that the company would have to make a decision on whether to increase prices.
Importing trouble?
The power sector is yet another that will be ravaged by the rupee’s volatility. With the scarcity of coal in India, the last couple of years have seen power players sprint across the globe searching for secure imports – some even bought up coal mines in Australia and Africa.
While analysts say that this was a good strategy as international coal prices have since depreciated, companies have been unable to leverage this opportunity due to a weak rupee. It is possible that the depreciating rupee will also dent margins if there is a spike in fuel costs, making it unviable for power companies to operate with imported coal.
In aviation, as 70% of an airline’s operating costs are incurred in dollars, it is likely that profits from domestic operations will fall. In addition, as some airlines are expanding their fleet it is expected that there will be further pressure on their bottom lines. However, airline officials say that the current cut-throat competition in the sector will inhibit airlines from passing on the costs to passengers.
India’s second largest airline, Jet Airways, attributed its ₹3.5 billion (US$54.5 million) loss in the quarter ended June to a weak rupee, high fuel costs and increases in airport charges in major cities.
Now for the good news
Companies in information technology (IT) and garment manufacturing, two of India’s largest export-oriented sectors, are seen to be the biggest beneficiaries of the rupee’s slide. IT firms – several of which were already sitting on piles of cash – get more than half their revenue from their overseas operations. Even though the growth rate of the IT and business process outsourcing sector has shrunk from 20% at its peak to 12% as it now stands, the depreciating rupee has been good for the sector.
However, Siddharth Pai, the president of ISG Asia Pacific, a global tech advisory firm, is not very bullish about the situation as he expects that inflation will negate the benefits of the deflated rupee on the IT sector. “The margin cushion that depreciation has given companies will decrease,” he says.
As is to be expected, IT firms want to make the most of the situation. With more money at their disposal they are using this period to strike deals.
With international operations accounting for 75% of revenues at Infosys, the company made its largest acquisition so far late last year – Lodestone in Switzerland for US$350 million. This has bolstered the company’s presence in Europe, the Middle East and Africa.
Tata Consultancy Services, the IT arm of the Tata Group, has made clear its intention to take risks. Speaking recently to the Business Standard, the chief financial officer, Rajesh Gopinathan, said: “A depreciating rupee allows us to be a bit adventurous in our deal-making. That means our ability to take on longer gestation deals and long cycle time deals increases. But I also want to be cautious as easy money leads to expenses creeping up.”
Harsh reality
There is also the issue of retaining clients. When a currency depreciates, clients tend to get jittery and look at alternatives in other countries. The Crisil report says that exporters who usually would have benefited from a falling currency may not reap the full benefits of a weak rupee as overseas clients may seek to review business contracts.
This is true for the garment manufacturing sector. The weak currency has provided a big boost for the export-oriented textile industry, but slower global consumption and higher input costs are weighing it down.
“At the moment we are happy because a fair number of our orders were negotiated when the rupee was between 45 to 55 to a dollar,” says Rahul Mehta, the managing director of Mumbai-based Creative Group, who heads the Clothing Manufacturers Association of India. “But we know the profit is just for the short term and not some kind of a bonanza.”
Fighting back
On 14 August, in an effort to prop up the battered rupee, the RBI unveiled a host of measures to restrict foreign exchange outflows. These have reversed the easing of capital controls by limiting the amount of money Indian citizens can remit abroad and businesses can invest in foreign ventures.
While the RBI also imposed a ban on imports of gold coins and medallions to curb the current account deficit, it said that gold importers would have to pay upfront for their purchases and that a minimum of 20% of the gold imported will have to be re-exported. Banks are also barred from giving loans against units of gold mutual funds and gold exchange-traded funds. In addition, the limit for foreign direct investment for domestic companies is down from 400% of their net worth to 100%, restricting companies from making big acquisitions.
Two days later, India’s finance minister, P Chidambaram, clarified that the measures were not retrograde and would be wound up at the right time. That is something that India Inc knows will not happen anytime soon.
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