Rupee impact on earnings has increased ‘manifold’, says RBI study

As the domestic economy becomes more integrated with global economy, the impact of macroeconomic factors such as forex rate on earnings has risen


This increased correlation between exchange rate and corporate earnings has been particularly visible in the post-2009 period. Photo: Priyanka Parashar/Mint
This increased correlation between exchange rate and corporate earnings has been particularly visible in the post-2009 period. Photo: Priyanka Parashar/Mint

Mumbai: The impact of currency movement on the earnings of Indian companies has increased sharply since 2009, concluded a working paper by the Reserve Bank of India (RBI) released late on Monday.

The paper, which analyses the impact of various macroeconomic factors, said that as the domestic economy has become more integrated with the global economy, the impact of macroeconomic factors such as the exchange rate, interest rate and wholesale inflation rate on corporate earnings has been amplified.

This increased correlation has been particularly visible in the post-2009 period.

“Among the macroeconomic indicators, the USD/INR rate was a significant factor whose importance has increased manifold in the recent time,” said the working paper authored by Shaoni Nandi, Debasish Majumder and Anujit Mitra at RBI’s statistics and information management department.

During 2002-07, corporate profitability was more impacted by firm-specific factors such as firm size, leverage ratio and liquidity ratio, among others. While currency movements were a relevant factor even in that period, its impact was not as high as seen in the post-2009 period.

After 2009, the domestic economy became more integrated with the global economy and also more sensitive to external shocks which, in turn, made macroeconomic factors more relevant to corporate profitability.

The rupee exchange rate and wholesale inflation rate are observed to be the most significant macroeconomic factors impacting EBT (earnings before tax) margins, found the study. Return on assets of a firm was most impacted by the exchange rate and RBI’s benchmark policy rate.

“.. it can be inferred that when rupee appreciates, corporate performance is likely to get a boost in terms of profitability, though in the long run, the impact would depend on the import and export elasticities. This gels with the nature of our corporate sector carrying out more imports than exports. As import gets cheaper when rupee appreciates, corporates are likely to be benefited from that,” the paper said.

In a scenario of persistent large depreciation of domestic currency, the performance of the corporate sector is expected to be impacted negatively, which may in turn affect the banking sector, the paper said.

The findings seem broadly consistent with data sourced from corporate database provider Capitaline.

For instance, in 2008, the rupee depreciated 19% due to the fallout of the global financial crisis. For 2008-09, BSE 500 listed companies reported a net profit fall of 9.21%. In the previous year, profits had grown by a healthy 25%.

In 2011, the rupee fell 15.75% and profit growth of this set of companies declined to 1.16% in 2011-12 from nearly 19% the previous year. In 2013, a rupee depreciation of 11% coincided with a profit growth of 6.64% in BSE 500 companies, although this was higher than the profit growth in the previous year. To be sure, domestic and global demand driven factors would also have played a role in earnings growth.

The paper goes on to explain that in the post-crisis period, a number of non-financial firms have rushed to take advantage of the easy liquidity abroad, which has amplified the impact of exchange rate volatility on their profitability.

External commercial borrowings by Indian firms have risen over the past couple of years as high-rated firms have taken advantage of easy liquidity conditions to raise foreign currency loans and bonds. According to the most recent data on external debt released by RBI on 30 June, commercial borrowings jumped 32% between March 2014 and March 2015. The outstanding commercial debt at the end of March 2015 was $181.9 billion—38% of the total outstanding debt.

“When the forex (foreign exchange) market is under stress, it is observed that the exchange rate becomes the only critical factor to determine corporate profitability, dominating all other factors,” said the study.

The increased sensitivity of Indian companies to exchange rate movements is a key reason behind RBI’s insistence that companies hedge their forex exposure. Along with repeated warnings on the issue, RBI has also asked banks to make higher provisions against unhedged exposure of their clients. This has led to banks pushing their clients towards hedging exposures.

The hedging ratio of Indian companies increased to around 39% of total foreign currency exposure in 2014-15, compared with 15% the previous year, said RBI deputy governor H.R. Khan on 4 August. The hedge ratio in the June 2015 quarter increased further to about 41%, he said.

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