India is witnessing an unprecedented economic boom and is seeing increasing activity in the manufacturing as well as services sectors. Its export sector is thriving and various industry sectors such as IT, ITES, pharma & other sectors. While the growth rate is showing a positive trend, export-oriented SMEs, MSMEs and corporate are also more exposed to Currency fluctuations – for many of them an unfamiliar territory.
Export comes with many associated risks relating to the realization of payments and Currency exchange rates. Exporters are faced with a situation where costs are budgeted in Rupees and revenues are in foreign Currencies. It is very important to manage Forex fluctuations like any other business risks.
We can classify this impact as follows:
• Impact on exporters: Strengthening of the Rupee is a nightmare for exporters, while the weakening of the Rupee boosts their profit margins.
• Impact on importers: Strengthening of the Rupee favorably affects an importer as their payments for goods go down when the Rupee appreciates.
• Impact on borrowers: In this global economy, Indian firms choose loans in foreign Currencies over Rupee loans because they are cheaper. However, when accepting a foreign Currency loan, there is a risk involved relating to exchange rate fluctuations.
On 15th January 2012 ABC Diamonds (Exporter) enters into contract to export diamonds worth USD 1, 00,000 with payment to be received in US Dollar on 15th February 2012. The exchange rate prevailing on 15th January is INR 51. Now when he receives the payment on 15th February 2012 the spot rate of USD was INR 49, so this made him a loss only due to the fluctuating rate of currency which depends on many economics factors. He was expecting total payment of (1, 00,000 * 51) = INR 51, 00,000 but what he gets on 15th February was (1, 00,000*49) =INR 49, 00,000. The total loss to the exporter 51, 00,000 – 49, 00,000 = INR 3, 00,000.
There is a specific rate which is available at the time of purchase of a LOT (1 lot USD=1000) so as he is expecting the total payment of 1, 00,000 with payment to be received in US Dollar on 15th February 2012 so if he would have gone to future contracts then ideally he should have sold 100000/100 = 100 LOTS of USD on the future rate of USD. Then on 15th February buy 100 LOTS of USD at the prevailing rate of day. Here what the exporter has done has just minimized the risk of bearing a loss plus has gained profit out of the deal due to hedging with the help of exchange traded currency derivatives.
Now let us calculate how the exporter goes home with no loss plus an extra profit due to hedging. He sells 100 lots of USD at future rate of INR 53.00 and in the month of February he buys 100 lots of USD at the spot rate so he gets the benefit out of that also.
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