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Opinion

The Downside of Hedging

PV Subramanyam of subramoney.com had this to say, on Facebook:

Myth: When the currency gets weak, exporters make tons of profit.
Reality: Clients just call up and say gimme better rates or take your product back. Simple Math.

It is true, really, and one of the primary reasons hedging doesn’t work. So if you hedged at 50 (that is, sold dollars forward at 50) and the rupee went down to 55, then your customer is going to say look, we have people will to offer the same job for lesser dollars since the rupee is cheaper now. So cut your rates or lose my business – you can’t tell him that you hedged it at 50.

On the other hand if the rupee appreciates to 45, the customer won’t pay more, but after your hedge expires, further business will come in at 45 a dollar, meaning you get paid lesser.

Hedging is tough, because of competition and costs. 10% inflation causes costs to go up 10%; so if the rupee depreciates your costs are up too. But if the rupee appreciates, inflation won’t come down immediately (prices are sticky on the way down).

Hedges also may involve a mark to market payment – so someone who hedges by selling, say 100,000 dollars at Rs. 50 will need to pay Rs. 400,000 as mark to market losses, which needs to get covered by the income coming in.

Many companies continue to hedge all their exporsure = Ranbaxy is one. It’ll be interesting to see how their profits dip this quarter.