Now, the central bank has decided to increase the risk weights and provisioning requirements on banks' exposure to companies with unhedged forex exposure. This would raise banks' effective cost of funds and hit their net interest margins. Banks, in turn, are likely to pass on this burden to corporate clients by raising lending rates.
In recent years, there has been a big surge in foreign currency borrowings, owing to the wide divergence between interest rates in Indian and those in developed markets. Since 2005, Indian companies have sought RBI's permission to raise about $220 billion from the foreign market either though foreign currency convertible bonds (FCCBs) or through external commercial borrowings (ECBs). In comparison, at the end of FY12, the total outstanding borrowings of BS-1000 companies stood at about $490 billion, based on the current exchange rate. This indicates the growing role of forex loans in India Inc's growth plans. In the last three years, RBI sanctioned ECBs and FCCBs worth $95 billion.
The majority of these forex loans are lying unhedged. This exposes companies to large mark-to-market losses on their forex liabilities, if the rupee depreciates from current levels. According to a study by RBI, about 60 per cent of the forex exposure of companies was unhedged, and a sharp depreciation in the rupee in 2011 and 2011 forced many companies to go for corporate debt restructuring, as their forex loans became unsustainable.
Experts agree with the RBI move but warn there is no one-size-fits-all solution to the problem. "Ideally, a company should hedge all its forex exposure, but it costs money and the greater the currency volatility, the bigger the premium markets charge to provide a forward cover. So, most companies do a cost-benefit analysis based on their business conditions and then decide their hedging policy," says Kartik Srinivasan, co-head (financial sector ratings) at ICRA Ratings.
The hedging cost is linked to the yield on the 10-year risk government bond. Currently, it ranges from six to 6.5 per cent for a company planning to hedge its rupee liability against fluctuations in dollar value. For exporters, the cost of hedging dollar earnings is currently about two per cent. "Many companies don't want to incur this cost, as it makes foreign borrowings unviable compared to domestic borrowings. This is especially true in the case of top rated companies that can borrow at base rates from banks," says Revati Kasture, head of research at Care Ratings.
Many companies enjoy a natural hedge and don't want to incur the additional cost of hedging. Hedging also becomes unattractive for companies that enjoy high margins and can, therefore, absorb the short-term fluctuations in the cost of their imported inputs. "The rupee has been all over the place in the last four to five years, making it tough for companies to devise a right hedging policy," says Dhananjay Sinha, co-head institutional equity at Emkay Global Financial Services.