Mumbai: Unhedged foreign currency exposures by firms remain a major risk factor for emerging market economies, even as India’s position is somewhat better than others, according to an executive of the Reserve Bank of India (RBI).
RBI officials, including governor Raghuram Rajan, have time and again warned about unhedged foreign currency exposure by Indian companies and mandated banks to set aside more capital in case their customers are not hedged adequately.
The proportion of hedged external commercial borrowings (ECBs) and foreign currency convertible bonds (FCCBs) declined from 35% in 2013-14 to 15% in July-August 2014, according to the central bank’s estimates.
The latest to warn Indian companies was RBI’s executive director G. Mahalingam, who as a keynote speaker in a treasury summit on Wednesday said a fall in hedging is being seen in all emerging markets as they are enjoying stable exchange rates on steady capital flows from yield-chasing investors. RBI released his speech copy on its site on Friday.
In a recent working paper, Bank for International Settlements (BIS) said the outstanding dollar credit to non-bank borrowers outside the US has jumped from $6 trillion to $9 trillion since the global financial crisis.
“This could expose the corporates in EMEs (emerging market economies) with large forex exposure to significant interest rate and currency risks unless these positions are adequately hedged," Mahalingam said. Such greater exposure will increase vulnerabilities for both local banks and the financial system more broadly.
“A point of comfort for India is that the Indian corporates do not contribute significantly to this increased exposure" because of the macro prudential measures put in place in India; however, “if a wave of corporate defaults happen in other EMEs, this can lead to some cascading impact on India and its financial markets," Mahalingam said in his speech.
Foreign investors will unwind their positions in the country if US interest rates go up and rupee-dollar exchange rates will be affected. Indian companies should improve their risk management practices to avert huge losses on account of exchange rate movement. Thus, they should hedge more, he said.
“While large treasury profits are alluring, it should not become an all-consuming passion exposing the corporates to unacceptable risks. Every corporate needs to formulate a well-deliberated hedging policy and ensure strict adherence to it," he said, while warning that the belief that RBI will lean against the wind in the event of sharp depreciation of the rupee to save companies is a “misconception."