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Impact of forex on India Inc's profits has risen
Thu, 20 Aug Pre-Open

Reserve Bank of India (RBI) recently released a paper highlighting the impact of foreign currency movements on Indian corporates.

  • Rupee appreciation is considered to be a good sign for an economy like India where the imports are larger than the exports. As imports get cheaper when rupee appreciates, the corporates are likely to benefit. This is barring sectors such as IT and pharma, which rely more on exports. Amongst the things we import, the most crucial is oil.

  • But, in a scenario, where the rupee declines, our oil bill goes up. This then has a direct bearing on fuel costs in the country and everything that depends on fuel, also sees prices going up. Rupee depreciation also becomes a problem for companies who have too much foreign debt on their books as the value of debt in rupee terms goes up.

  • Forex movements also have an impact on the gross non-performing assets (NPA) of banks. Lets understand the same with the help of an example.  China, recently, devalued its currency, the Yuan. A weaker Chinese currency is likely to mean reduced competitiveness of goods manufactured in rest of the world. Add to that the fact that there could be the dumping of commodities from China to other markets including India. And put further pressure on commodity companies in India, which are already grappling with the problem of low prices. Recently, a report by Credit Suisse highlighted the steel sector to be a key source of stress for banks in FY16 as well as FY17. As on date, banks' total exposure to the steel sector stands at a whopping Rs 3,000 bn. That of SBI alone stands at little over Rs 757 bn as on June 2015.

  • As per an article published in Livemint, the corporate profitability during 2002-07 was impacted more by firm specific factors such as firm size, leverage ratio and liquidity ratio. However, although currency movements were a relevant factor even in that period, the impact was not as high as seen in the post 2009 period. Post 2009, the domestic economy has become more integrated with the global economy. It has also become more sensitive to external shocks. And thus, volatile foreign exchange movements have more of an impact on the profitability of India Inc than what they did earlier.

  • The increased sensitivity of Indian companies to exchange rate movements is a key reason behind RBI's insistence that companies hedge their forex exposure. Along with repeated warnings on the issue, RBI has also asked banks to make higher provisions against unhedged exposure of their clients. This has led to banks pushing their clients towards hedging exposures. The hedging ratio of Indian companies increased to around 39% of total foreign currency exposure in 2014-15, compared with 15% the previous year.

  • It is difficult to take a call on the direction of the rupee. But investors would do well to keep a tab on the extent to which a company's business is exposed to foreign currency movements. The other thing that they need to watch out for is the amount of foreign debt that companies have on their books.  And then, among other things, make their investment decisions accordingly.

    • For information on how to pick stocks that have the potential to deliver big returns, download our special report now!

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