Tirupur: When Britto M. Joseph, managing director of JVS Group, based near the textile capital of Tamil Nadu, found that the complex derivatives products he held were spiralling downwards, he sold them. That was in December, and it took him less than 90 days to discover he could lose lots of his export earnings clinging on to the complex financial product his bank had persuaded him to buy.
“We exited when we found it to be risky,” said Joseph, who did not divulge further details of the contract.
Safety net: A file picture of a worker in a textiles factory tending to his machines. Tirupur Exporters’ Association president A. Sakthivel says exporters in the city play safe, booking only forward contracts.
Joseph, it now seems, was in the minority in Tirupur town, and better still, lucky to get out at the right time. Exporters that Mint spoke to said they were aggressively wooed for months by several banks to buy complex financial instruments to hedge their losses from a rising rupee, and the only reason most of them stayed away from buying them was because the banks themselves often couldn’t explain to the exporters how the derivatives worked. But, they say, that still didn’t prevent the banks from trying every sales trick to try sell them.
The exporters, however, refused to name the banks, saying it would ruin their relationship with the financial institution which they also depend on for everyday business.
Joseph’s company, which has export earnings of Rs200 crore and counts Wal-Mart Stores Inc. and Tesco Plc. as clients, had taken derivatives products to cover only a small portion of foreign exchange payments they expected from their sales to overseas firms.
At the time, the rupee was rapidly rising against the dollar, forcing exporters to find ways to stem losses arising from the conversion of the dollar payments into rupees. In short, they were finding ways to make sure they would get, say, Rs41 per dollar, instead of, say, Rs39.20 as the rupee gained. “Here (referring to Tirupur exporters), people play safe, they only book forward contracts,” said A. Sakthivel, president of Tirupur Exporters’ Association (TEA), an industry body.
A forward contract, in the case of exporters, could be an agreement to sell their export earnings (usually in US dollars) at a particular exchange rate and on a given date, both of which are fixed.
In contrast, derivatives could use a portion or all of the export payments due to them as the underlying asset, and place a bet on the trading level of other currencies, such as the yen or Swiss franc. Often, the bet is a multiple of the value of the underlying assets, which is defined as leverage.
For example, a firm could offer $10 million (about Rs40 crore) of its future export earnings as underlying asset, and enter into a derivative contract worth $100 million that bets on a weakening Japanese yen. However, when bets go wrong, such as in this case when the yen gained against the dollar, firms could incur huge losses.
In the last two months, several firms ranging from banks themselves to others have said they have lost money on complex derivative products that they held without knowing the full risk and also in part because an eight-month global credit crisis triggered by massive piles of non-recoverable debt sitting with banks ended up being deeper and spreading wider than expected.
That’s caused wild fluctuations in currencies and equities and the debt spliced and dressed in different complex products has ended up on many company books. As a result, some of the firms have filed suits against banks, as reported by Mint in an ongoing series of stories.
Six Tirupur-based exporters, who between them have combined export earnings of more than Rs1,200 crore, said, while in almost all cases they couldn’t understand the complex derivative products, they also didn’t want to jeopardize their only income—from export earnings. “So far, no one has come forward with losses from derivative contracts. Most did not buy these products as the awareness about them (derivative products based on export earnings) was absent,” said Sakthivel.
However, new private sector banks have aggressively tried to sell these complex derivative products to Tirupur exporters, which clocked around Rs12,000 crore worth of exports last year.
“The banks tried very hard to sell the products. When we initially said no, they came back and asked us to offer only 10% of our export receivables,” said D. Prem, chairman of the Prem Group, which will achieve an export of Rs100 crore in 2007-08.
Prem said banks did not properly explain the risks involved in those products, adding that they were only interested in selling rather than providing information. “I was too afraid as the risks involved were huge”, he said.
Prem Group, however, has taken a forward cover for 70% of its exports. In the case of one large listed textile firm, banks advised it to set up a treasury team within the company and trade in such derivative products and in the commodities market.
But, the company took a decision to focus only on its primary business, said a senior official, who did not wish to reveal his identify fearing it might hurt the company’s relationship with the banks.
Royal Classic Group (RCG), which has domestic and export operations, too, did not buy the derivatives products; instead, they opted for forward contracts, said R. Shivram, executive director of RCG. The company, which sells domestic brands such as Classic Polo and Smash, had an export revenue of Rs125 crore for the year ended March 2007.