Forex fluctuations on

imports & exports: A

profitability analysis of
SMEs.
A Paper Presentation
By

Kushaal Subramony
Sony Saju George
Remya Josephine Antony
Sreeja Sukumaran
Teby C Baaby
Gangaveer Singh
 INTRODUCTION
• India is among one of the prominent importers and
exporters of the world.
• The engagement in imports has exposed businesses to
exchange rate risk, which acts in favour of the importer
sometimes while other times can lead to a financial havoc.
• Last year due to recession, Indian Rupee depreciated
greatly, impacting Indian importers immensely as it lead to
an increased cost of product acquisition.
• Unstable exchange rates affect businesses tremendously
and it is difficult to difficult to change the prices of products
accordingly.
• A number of banks and government organisations help
companies that are extensively involved in importing
activities.
• SMEs are adversely affected by the exchange rate
fluctuations.
 Market Forces and its Impact on
Exchange rate movements.

• Exchange rate movements are driven by Demand and

Supply principle.
• Some of the important factors affecting the demand and
supply of any currency are as follows:-
Interest Rate parity
Law of one price
Macro-Economic Environment
Stock Market
Political Factors
 INTEREST RATE PARITY
Any disparity between the interest rates of two countries is
equalized by the movement in their currency exchange rates.
• Sometimes known as the International Fisher effect.
• When one makes investments in two different currencies the
return on both the investments are the same even though the
interest rates may be different in absolute terms.

LAW OF ONE PRICE

• The same goods should be sold at the same price anywhere in
the world.
• Either the price of the goods or exchange rate must be adjusted
to adopt the same price.
 MACRO-ECONOMIC ENVIRONMENT

• A positive macro-economic environment also increases the

demand for a currency.
• The economic data about the below indicators are also likely to
cause fluctuations in exchange rates are :-
1. Consumer Price Index
2. Producer Price Index
3. Gross Domestic Product
4. Productivity
5. Industrial Production
6. International Trade
 STOCK MARKET

POLITICAL FACTORS
 Role of RBI in FOREX
• Sales and purchase of foreign exchange
• Intervention has changed over the years from Bretton
Woods system

Reasons
•To influence the trend movement in exchange
• To maintain export competitiveness
• To manage volatility to reduce risk
• To protect currency from speculative attack
• Increased importance of capital flows
•IMF principle of 1977 regarding central bank
intervention only for disorderly market
conditions
•Sterilised intervention – Offset government
debt
•Non sterilised intervention – Without offset
• Studies show that intervention can contain
exchange rate volatility
• To match demand and supply of foreign
currency
March 1993 – July 1995(Stability)
• Dual exchange rate to Unified exchange rate
• Capital inflows tended appreciating pressure on rupee
• Reserve bank foreign asset raised to $20 Billion
• Preserving competitiveness and building reserves

August 1997 – August 1998(Volatility)

•South East Asian currency crisis

• High volatility
• Adoption of stringent monetary and administrative
measures in spot and futures
How does RBI manages exchange rate
in the interbank market?

Quantitative Measures
• Foreign Exchange Exposure Limit (FEEL)
• Basically restricts the banks to keep a net asset
(long) or net liability (short) position in foreign
currencies.
• Presently FEEL for each bank is set at 10 % of
it’s paid up capital.
• In the presence of FEEL, banks’ net purchases
or net sales in foreign exchange on a given day
have to be within their FEEL.
 Physical intervention
• Direct selling or buying of foreign exchange
by State Bank in the interbank market.
• Such sale/purchase can be in spot or forward
value
• It can have two objectives
To provide support to the market for
lumpy payments
To manage the Rs/$ parity

• Intervention may be direct or indirect.

Currently RBI only indirectly intervenes in the
market.
 Impact of forex fluctuation on SMEs

• Wild foreign exchange fluctuation has

been taking a toll on India Inc and has not
only caused losses, but also created a
huge confusion over the hedging solution.
• Both exporters and importers are
concerned about the uncertainty caused
by the volatility.
 Impact of the appreciation of the
rupee on various sectors
Industry % of imported % of exports impact
content

Leather Low High Adverse

Refineries High Low Beneficial

Auto Medium Low Beneficial

Engineering Medium Low Beneficial

Airlines High Low Beneficial

Gems and High High Neutral

Jewellry

IT Low High Adverse

handicraft low high Adverse

 Impact on exporters

• Currency appreciation adversely impact

exporters while currency depreciation
benefits exporters.

Impact on Importers

• Currency appreciation impacts the

importers favorably as it reduces the cost
of imported goods
 Impact on Borrowers

• Indian firms are availing of loans in

foreign currencies as these loans are
cheaper than Rupee loans. However,
when taking a foreign currency loan,
there is a risk related to exchange rate
fluctuations.
CURRENCY FUTURES
 What are Currency Futures?

• Futures are
– standardized,
– negotiable, and
– exchange-traded contracts to buy or sell an
underlying asset
• In case of Currency Futures the underlying asset is the
exchange rate.
– In India only those contracts based on USD/INR
are traded.
 Why Currency Futures?

• Exchange Rate fluctuates

• Expose investors to currency risks.
– If domestic currency depreciates (appreciates)
against the foreign currency, the exposure would
result in loss (gain) for importers and gain (loss)
for exporters.
• Currency futures enable traders to hedge their
FX risks.
– taking a position in the future market that is
opposite to a position in the physical market
How Currency Futures can Help?
• Unhedged Exposure: Let’s say on March 1, 2008, an Indian
refiner enters into a contract to export 1000 barrels of oil with
payment to be received in US Dollar (USD) on June 1, 2008.

The price of each barrel of oil has been fixed at USD 80/barrel at
the prevailing exchange rate of 1 USD = INR 44.05; the price of
one barrel of oil in INR works out to be is Rs. 3524 (80 x 44.05).

On June 1, 2008, the INR actually appreciates against the USD

and now the exchange rate stands at 1 USD = INR 40.30.

Hence the same barrel of oil that initially would have garnered
him Rs. 3524 (80 x 44.05) will now realize Rs. 3224, which
means 1 barrel of oil ended up selling Rs. 3524 – Rs. 3224 = Rs.
300 less and hence the 1000 barrels of oil has become cheaper by
INR 3,00,000.
Courtesy :NISM
 Hedged

Since he is concerned that the value of USD will

fall he decides go short on currency futures, it
means he sells a USD/INR future contract. This
protects the importer because weakening of USD
would lead to profit in the short futures position,
which would effectively ensure that his loss in
the physical market would be mitigated. The
following figure and exhibit explain the
mechanics of hedging using currency futures.

Courtesy: NISM
Currency Futures-An effective risk management
tool

• Currency Futures is very important risk

management tool, in face of wide fluctuations
in FOREX Rates.

• Small exporters don't have right risk

management policy. Currency Futures and its
adoption by the SMEs can help in remedying
these.
 Risk exposure strategies

• Foreign currency receivables holdings.

• Price competitive markets
• Price variance clauses with customers
• Cash flow position
• Fluctuation and significant effect on
profits
• Which currencies are you exposed to?
 Risk mitigation strategies

• No hedging
• Selective hedging
• Systematic hedging
 Risk mitigation tools

• Currency diversification
• Forward contracts
• Swaps
• Call and put options
SOLUTIONS OFFERED BY
BANKING & FINANCIAL
INSTITUTIONS
 SPECIALISED PRODUCTS
OFFERED
• Interest Rate Product – Principal Only
Swap (POS)
• Exchange Rate Product – Forward
Booster
Interest Rate Product – Principal
Only Swap (POS)
• Change a liability of interest.
• Example of POS
 Exchange Rate Product –
Forward Booster
• It is an option contract
• Example of exchange rate product
Thank you