The 7% depreciation in the rupee last quarter led to a str-ing of losses on foreign exchange hedges taken by Indian firms to protect themselves against the risk of the currency appreciating. But, in a number of cases, these losses were more than offset by gains in operating revenue and profit.
Take, for instance, India’s second largest software company, Infosys Technologies Ltd, which recently reported a mark-to-market loss of about Rs80 crore on its forex hedge position. It also reported that operating profit for the June quarter rose by about Rs120 crore because of the rupee depreciation. The net result of the rupee depreciation was a gain for Infosys, and for many other firms, who hedge their revenues and receivables in the forex derivatives market.
The losses on the hedge position is just one side of the story. A number of exporters gained more on the operational front because of the domestic currency’s depreciation. As S. Mahalingam, chief financial officer of Tata Consultancy Services Ltd, says, “We’d rather book revenues at 43 and take some losses on our forex hedges, than book revenues at a much lower rate and have some gains on our hedges.”
Not all firms were lucky enough to see the net result of the rupee depreciation being a gain. Take the case of MindTree Ltd, whose entire quarterly profit was wiped out after its investment in forex derivatives was calculated at current market value.
But, even in such cases, it’s not entirely accurate to term the mark-to-market hit on a forex hedge position a “loss”. Just three months ago, most analysts were predicting that the rupee would continue to rise and reach levels of about 36-38 against the US dollar. At that time, rupee was hovering between 39.5 and 40. For an exporter like MindTree, it would have made sense to lock in future revenues and receivables at rates above 40 by going short in the derivatives market. And that’s what it did.
In hindsight, it may seem silly to be stuck with short positions at levels of 40-42, with the rupee now hovering around 43. But that’s not the right way to judge a hedged position. By hedging using the forex derivatives market, MindTree essentially locked in a rate at which it would realize its revenues and receivables in the future. Regardless of where the rupee traded at the time these derivatives contracts expired, the firm would be assured the rate at which it was locked in.
True, the company lost the opportunity to realize its revenues at the higher rate of 43, but its hedges also removed the probability of realizing revenues at, say, a rate of 36, if the rupee had moved in the opposite direction.
Of course, some firms went overboard with their hedges, taking positions in the forex derivatives market that expire even five years from now. This was because of the fact that the rupee was headed in one direction for most of the past year, and it seemed like it can only appreciate in the long term. But, with the sharp depreciation in the rupee, companies such as HCL Technologies Ltd have been forced to unwind some derivatives positions and book cash losses. (Note that this is different from notional mark-to-market losses, which are by and large offset by gains in operating profit.) HCL Technologies, with $2.5 billion (Rs10,675 crore) in hedges at the end of March, had cut the level to $1.7 billion by the end of the June quarter.
Then there are firms such as Hexaware Technologies Ltd and a number of small exporters who bought exotic derivative products, which weren’t proper hedges to begin with. On the contrary, they were speculative positions. The losses these firms have reported are truly losses.
Options trading gets popular
On four occasions this month, including Monday, the turnover of index options products on the National Stock Exchange has exceeded that of index futures trading. So far this month, the segment has contributed 31% of all equity derivatives trades on the exchange, equalling the contribution of the stock futures segment.
This column had pointed to the rising popularity of Nifty products in March, but even then most of the demand was for index futures. Index options had accounted for only 15% of total turnover that month. Before the markets tumbled in January, they accounted for just 8% of total derivatives turnover. In absolute terms, average daily turnover has nearly trebled since January. The current political uncertainty seems to nudging options trading to new heights. The markets could move sharply in either direction depending on the outcome of the trust vote on Tuesday, and a number of market participants seem to be hedging their bets by buying options. With index futures, both the upside and downside is unlimited, but with options, the downside is limited to the premium paid to buy it. This explains the recent flurry of options trades. The implied volatility on Nifty options has exceeded 50%, which essentially implies that option sellers are extracting their pound of flesh in the bargain.
The stock market regulator’s decision to introduce long-dated options has also helped increase the popularity of the segment. Long-dated options accounted for 15% of all index option trades on Monday. Traders say that some of these positions are hedged using the more liquid near-dated options, enhancing overall liquidity of the segment. Whatever the reasons, it’s heartening to see that a market that was primarily driven by speculation till only six months ago has now taken so well to options trading.
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