Managing Foreign Exchange Risk in volatile times
The foreign exchange
market is witnessing unprecedented volatility with the Rupee-dollar exchange
rates moving from Rs. 44.1 per USD to Rs. 54.2 and back
to Rs. 52.7, all within the last five months. Expert opinion on the direction
of future rates is divided, with predictions across the spectrum. While many experts
expect further depreciation to as high as Rs. 58 per USD, equally strong is the
assertion of others who claim this to be an aberration and expect exchange
rates to revert to Rs. 45 per USD. Such divided opinion leaves corporates that
have foreign currency exposures perplexed on the strategy they need to
adopt. A robust risk management policy,
founded on few simple ground rules, can help manage foreign exchange risk and
avoid serious consequences.
PREDICTIONS ARE FOR EXPERTS
Guessing the direction of exchange rate is
like predicting the weather. It is a full-time
job for professionals and experts, and not the business of an entrepreneur or a
corporate finance manager. Even predictions by experts are fraught with risks;
relying on such predictions and exposing the company to such risks can seriously
affect the financial health of the company.
Unless the balance sheet can withstand big shocks, companies –
especially small and medium enterprises – should mitigate all their foreign
currency risks through appropriate hedging. Companies that leave foreign exchange
exposures un-hedged in the hope of exchange gains more often than not end up
hurting their profitability.
NATURAL HEDGE MITIGATES RISK
Exchange rates have strong influence on
prices of several products, especially those involving commodities such as petrochemicals,
aluminium, copper and steel. This is
because the base commodity prices are more often determined using landed prices
of imports. Companies in such sector may enjoy certain natural hedges against
adverse exchange rate movements, and the need for hedging their foreign
currency liabilities could reduce to this extent. Companies
with significant foreign exchange transactions should seek professional help to
quantify net foreign currency exposure and identify strategies to mitigate the
same.
RISK MANAGEMENT POLICY
A sound risk management policy is a must
for medium and large businesses to serve as guide for business managers in
managing foreign currency exposure. This
helps in calibrated degree of risk taking, quantifying stop-loss levels and
also prevents speculative positions which have wrecked havoc in many companies
in the past.
The current weak global economic outlook
has added to the volatility of exchange rates, rendering any meaningful
prediction of exchange rates extremely difficult even for experts. In such
vulnerable economic environment, companies should avoid guessing and put in
place strong risk mitigation strategies.
N.
Muthuraman is Director, RiverBridge
Investment Advisors Pvt. Ltd., a boutique financial advisory firm and can be reached at muthuraman@riverbridge.in
This is the blog of the Print
Version published in Business Line dated 26th Dec 2011
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