New Delhi: Indian metal producers and consumers are flocking to commodity exchanges to hedge their exposure to volatile prices after government restrictions were relaxed.
Firms face new perils if they dabble in this potentially expensive and high-stakes game.
In April, the Reserve Bank of India amended rules that limited hedging to importers and exporters of metals, allowing firms to hedge even if their price risk was solely in the domestic market.
“Within a couple of years, a majority of companies in India dealing in the commodities market would be at least prepared for hedging,” said Vikram Dhawan, head of commodities of Reliance Mutual Fund, one of India’s top funds in asset value.
Hedging allows firms to lock in prices at set levels by offsetting a physical position with an equal and opposite position in a futures market.
But hedging brings its own risks. In the case of nickel, prices have fallen nearly 50% from record highs in May, but if consumers had put a hedge at those higher numbers, they would not benefit from the recent price move.
The main drawback of hedging is the cost. Clearing houses insist that position holders pay margins - lines of credit or deposits that cover the largest likely one- or two-day move in prices of an asset - on open positions to guard against default risk. “If you hedge excessively, then you can create cash flow problems,” Dhawan said, adding that paying margin money alone could pose problems. On the other hand, hedging too little may not provide insulation from volatility.
“After the regulation change, we see an increasing interest from Indian metal producers to hedge on the London Metal Exchange,” a London-based trader told Reuters. “Every day, more and more companies are contacting us to trade metals. Usually a brokerage firm based in India contacts us rather than the company itself.”
At least 20 to 30 traders are likely to hedge this year, including auto makers, equipment manufacturers and cable suppliers.
Nick Trevethan in Singapore contributed to this story.