Are forex bonds really low cost?

Mon, 28 May Pre-Open

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The falling rupee spells good news for export-oriented companies. These companies are able to earn a higher rupee value for their dollar-nominated receivables. However they say that one man's pound of flesh is poison for the other. The import-dependent companies find themselves in a spot as they are forced to shell out more rupees for their overseas purchases. Even companies that have raised funds through Foreign Currency Convertible Bonds (FCCB) face heat from rupee value depreciation.

FCCB is similar to a debt instrument. Only the currency underlying FCCB is a foreign currency. Like bonds, funds raised through FCCBs entail regular interest (coupon) and principal payments. Additionally, FCCB holders have the option to convert bonds into stocks at a pre-determined price on a future date.

Issuers of FCCB's face the impact of weak rupee on two counts. Firstly, the falling rupee inflates their debt burden. This translational difference has to be booked by companies as mark-to-market (MTM) losses, adversely impacting their profitability during the quarter. However, companies with forex exposure received some relief recently. The Government, in January 2012, extended the transitional provisioning to Accounting Standard 11 up till March 2020. Accordingly, companies can accumulate the MTM differences on long-term forex loans in a separate account in the balance sheet. The MTM differences can then be amortized over the life of the underlying monetary item not extending beyond March 2020. In other words, companies have the option of deferring losses on forex loans and thereby mitigating the short-term volatility in their reported earnings.

The second impact of weakening rupee on FCCB issuers is more far-reaching. It results in higher interest and principal outflows straining the company's cash flows. Big companies like Tata Steel, Tata Motors, JSW Steel, Jaiprakash Associates and Suzlon Energy have their FCCBs maturing over the next six months. While large companies traditionally hedge their dollar exposure. But this time around, the rupee slide has been quite rapid leaving companies without adequate hedge. As stock prices of these firms are mostly quoting below their conversion price, they are unlikely to be converted into equity shares by bond holders. Therefore, unless Reserve Bank Of India (RBI) measures provide some strength to the rupee, companies will find it increasingly difficult to service their FCCB obligations.

Mid-cap companies facing FCCB redemption pressures are seeking RBI approval for bond restructuring. But this along with the lack of transparency by the issuing companies is expected to cloud the credibility of the Indian FCCB market.