Corporate India is sitting on a fresh round of problems and losses on foreign exchange derivatives though on a lower scale than those on exotic products.

This is because when the rupee was appreciating, exporters rushed to cover and sold their dollar receivables forward. Some sold their dollars forward not just for a year but for three to five years, said foreign exchange observers.

With the rupee depreciating 7 per cent, exporters face losses on these contracts. "An exporter may have committed to sell his dollars forward at Rs 40; on Thursday the rupee is trading at Rs 42.50. It's an opportunity loss,'' said a forex expert. What this means is that if the rupee continues to trade at this level, exporters will realise seven to eight per cent lower on their receivables.

Luckily, exporters have entered into this contract only for a third or half of their exports, said experts. Which means an exporter will suffer a loss only to the extent he has covered. It will also mean that higher the quantum of exports or the cover a corporate has taken higher will be the opportunity loss on these contracts.

The losses would be higher in cases where an exporter has tried to sell his dollar receivables for a longer term, say 3-5 years. Many exporters, who went for these contracts, actually did that to get a higher rate for these contracts.

Interestingly, these contracts are relatively less complex than the exotic products sold earlier by banks to corporates, some of whom went to court to declare these contracts void as they totted up huge mark-to-market losses on those contracts.

Leveraged Options
To get a better rupee-dollar rate, exporters went for leveraged options. To make it a zero-cost strategy, they went for a 1:2 leverage option and bought one put and sold two calls. A put gives you the right to sell while a call gives a right to buy; here since they are selling an option, they have an obligation to sell.

An option is a contract which gives a buyer a right, but not an obligation, to buy a currency at a pre-determined rate, known strike price, for settlement at a future day. The buyer of an option contract buys the right to exercise the option while a seller of an option has an obligation to honour the contract.

"In a 1:2 leveraged option when you are selling 2 calls, you are giving someone else the right to buy twice the amount,'' said a Delhi-based forex consultant.

The options are settled at the strike price. If the spot rate on maturity is higher than the strike price of the option, the exporter has to sell at that strike price. If the dollar fell below the strike rate (say Rs 41), exporters need to sell 1 million dollars at the strike rate.

Similarly, if the dollar goes above the strike price, the exporters would sell 2 million dollars at the strike price (in a 1:2 leverage option). Typically, these contracts have a monthly-fixing (at the end of the month) called monthly-strips and exporters could go for a one-year to five-year contract.

It's an opportunity loss for the exporter, who had entered into an agreement to sell his dollars at Rs 40 while the market is above Rs 42 (Rs 42.90 on Tuesday). The market has moved by Rs 3. What looked like a good rate earlier does not look like a good rate on Thursday,'' added the forex consultant.

The strike price (at Rs 40/Rs 40.50) on most of these contracts is much lower than the current rupee-dollar rate (Rs 42.90). Though these could be long-term contracts of two to five years, the contracts have a monthly-fixing which means the difference in rates have to be settled at the end of the month.

"Nobody expected the rupee to go so high. Even if you have done a five-year contract, the best rate one could get is Rs 41.50 or Rs 42. Given the current price (rupee-dollar rate), it's an opportunity loss for exporters,'' said an expert.

It's not just an opportunity loss, but actual loss as well. "Since these are leveraged options (there's 1:2 leverage), the exporter has to sell twice the amount of dollars. In case they don't have dollars to sell, they have to settle the difference in cash. Companies would incur actual loss on these contracts on the fixing dates last month and will do so again this month,'' added an expert.

Banks may ask for additional margins. The losses are not as big as those on exotic contracts. Besides, if the rupee has depreciated 7 per cent in a month, it could recover 3-4 per cent of lost ground quickly when markets improve.

"When the rupee was appreciating, companies were pushed to go for these options from their boards of directors. The losses would not be disclosed separately but will be reflected in lower sales realisations,'' said a Mumbai-based foreign exchange consultant who advises mid-cap companies.

"When the rupee was appreciating, experts said it may touch Rs 37-38 level. So, exporters sold their receivables forward as they wanted to protect themselves. Exporters had suffered when the rupee appreciated 12 per cent, from Rs 44 to Rs 39. They wanted to make sure they did not go wrong again,'' said an expert.

Take the IT industry. When the rupee was appreciating, software companies hedged their receivables, though it varies widely across companies. "People wanted certainty, and have traded it off with future upside that they might have made from the depreciation of rupee,'' said Mindtree's CFO Rostow Ramanan.

Analysts say typically, Infosys hedges three months of receivables, TCS has taken cover for $3-4 billion, amounting to 50-70 per cent of its sales while mid-size IT firms like Mindtree have covered 50 per cent of their receivables.

"If companies have over-hedged themselves and gone for exotic products and longer term (3-5 years), they may have a problem. As long as companies have done sensible instruments, there won't be much of a problem,'' added Ramanan.

Conversely, companies that have more of un-hedged receivables will benefit.

With the rupee appreciating from Rs 43.20 to Rs 42.50 against the dollar in the last few days, exporters who went for these contracts would have got a breather.

The Rupee's appreciation is dependent on the flow of foreign funds, which has dried up. Till the flows were strong, the rupee was appreciating,'' said a Mumbai-based forex expert. So, the fate of these contracts will depend on funds flow and the extent of volatility in the forex markets.