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Chapter 4

The Problem of Currency Exposure and its Management in India

4.1 Introduction

Presently India is the fourth9 largest economy in the world. The Indian economy

witnessed a growth rate of 8.6%10 and is expected to grow at 9% for the year

2011-12. India is among the fastest-growing countries in the world. The size of

India’s economy is now poised to touch $2 trillion in the year 2011-1211. If one

assumes the current exchange rate of Rs 45 per US dollar to hold in 2011-12,

the size of the Indian economy would be $1,996 billion at dollar rates.

India was under socialist-based policies for an entire generation from the 1950s

until the 1980s. The economy was characterised by extensive regulation,

protectionism, and public ownership, leading to pervasive corruption and slow

growth 12. India encountered a full blown economic crisis at the end of the 1980s:

the balance of payments came under severe pressure, and a realistic threat of

sovereign default loomed over us; fiscal deficits had increased significantly over

the 1980s; and inflation began to creep up. India started having balance of

payments problems since 1985, and by the end of 1990, it was in a serious

economic crisis. The government was close to default, RBI had refused new

credit and foreign exchange reserves had reduced to the point that India could

barely finance three weeks’ worth of imports. Balance of Payments crisis in 1991

9 Source: Based on 2010 GDP figures. Available at http://www.economywatch.com/economies-in-top/ 10Source: Economy Survey 2011 11Source: Estimation based on Prime Minister’s Economic Advisory Council (PMEAC). Available at http://www.indianexpress.com/news/gear-up-for-the-2trillion-economy/756615/

12 Kelegama, Saman and Parikh, Kirit (2000). Political Economy of Growth and Reforms in South Asia. Second Draft. http://www.eldis.org/static/DOC12473.htm.

85

pushed India to near bankruptcy. In return for an IMF bailout, gold was

transferred to London as collateral, the Rupee devalued and economic reforms

were forced upon India. At that time there was a need to transform the economy

through badly needed reforms to unshackle the economy. Controls started to be

dismantled, tariffs, duties and taxes progressively lowered, state monopolies

broken, the economy was opened to trade and investment, private sector

enterprise and competition were encouraged and globalisation was slowly

embraced. Similarly establishment of a new unified market- determined

exchange rate and phased introduction of current account convertibility have

opened up the Indian economy to a great extent. Further, trade liberalization,

greater access to foreign capital and finally full capital account convertibility have

been certainly on the agenda of the Indian government.

In this chapter, an attempt is made to provide insight into the status of currency exposure management in India. Chapter starts with a brief introduction to Indian foreign exchange market and exchange rate

management in India followed by an analysis of reason for appreciation or depreciation of rupee against major currencies. Last and most important part of the chapter discusses the impact of currency exposure on Indian business enterprises and avenues available to Indian business enterprises

to manage currency exposure.

4.2 Indian Foreign Exchange Market

Market players in foreign exchange became active in the seventies after the

collapse of Bretton Woods Agreement. However, India was somewhat insulated

since stringent exchange controls prevailed. In 1978, banks were allowed by the

RBI to undertake intra-day trading in foreign exchange. This possibly marks the

beginning of foreign exchange market in India. When major Indian banks found

an opportunity to make profits in the foreign exchange market, they started

quoting two-way prices against the rupee as well as in cross currencies.

Gradually, trading volumes began to increase. Exchange rate regime in India

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between 1975-92 was characterized by daily announcement of buying and

selling rates by the RBI to Authorised Dealers (ADs) for merchant transactions.

The RBI performed a market-clearing role on a day-to-day basis, which naturally

introduced some variability in the size of reserves. Incidentally, certain categories

of current and capital account transactions on behalf of the Government were

directly routed through the reserves account. The developments in Indian foreign exchange market in post liberalization era can be analysed in the

light of the following reports13.

I. Rangarajan Committee

The recommendations of the High Level Committee on Balance of Payments

headed by C Rangarajan provided the basic framework for policy changes in

external sector, encompassing exchange rate management and, current and

capital account liberalisation. Based on the reports of the committee market

determined exchange rate regime was initiated in 1993 and current account

convertibility was finally achieved in August 1994 by accepting Article VIII of the

Articles of Agreement of the International Monetary Fund.

II. Sodhani Committee

Expert Group on Foreign Exchange (Sodhani Committee) studied the foreign

exchange market in great detail and in its report of June, 1995 came up with

across-the-board recommendations to develop, deepen and widen the Indian

foreign exchange market. Committee also recommended the introduction of

various products, ensuring the risk management and enabling efficiency in the

foreign exchange market by removing restrictions and tightening internal control

and risk management systems. On the basis of recommendation of the

committee the banks have been given freedom to participate more actively in the

foreign exchange market. Even corporate also have been given noticeable

freedom to operate in the foreign exchange market by permitting them to hedge

anticipated exposures, increasing the Exchange Earners Foreign Currency

13 Source: Reserve Bank of India

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(EEFC) account eligibility and given freedom to cancel and rebook forward

contracts.

III. Tarapore Committee:

Tarapore Committee on Capital Account Convertibility which was formed in

1997 had recommended a number of measures relating to foreign exchange

markets. Some of the measures undertaken on the basis of the

recommendation of the committee relates to foreign direct investment,

portfolio investment, investment in Joint Ventures/wholly owned subsidiaries

abroad, project exports, opening of Indian corporate offices abroad, raising of

EEFC entitlement to 50 per cent, forfeiting, allowing acceptance credit for

exports, allowing FIIs to cover their exposures in debt and part of their

exposures in equity market, etc.

4.2.1 Features of Indian Foreign exchange Market14

The key features of Indian foreign exchange market are as follows

I. Participants in Foreign exchange Market

The foreign exchange market in India comprises of Reserve Bank of India,

Authorised Dealers (ADs) in foreign exchange and customers. The ADs are

essentially banks authorised by RBI to do foreign exchange business. Major

public sector units, and other business entities with foreign exchange exposure,

access the foreign exchange market through the intermediation of ADs. The

foreign exchange market operates from major centres like Mumbai, Delhi,

Calcutta, Chennai, and Bangalore with Mumbai accounting for the major portion

of the transactions. Foreign Exchange Dealers Association of India (FEDAI)

plays an important role in the foreign exchange market as it sets the ground

rules for fixation of commissions and other charges and also involves itself in

matters of mutual interest of the authorised dealers.

14 Source: Keynote Address by Dr.Y.V.Reddy, at the 3rd South Asian Assembly, at Katmandu, Nepal, September 3, 1999.

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The customer segment is dominated by Public sector oil companies like Oil and

Natural Gas Commission, Indian Oil Corporation and certain other large public

sector units like Bharat Heavy Electricals Limited, Steel Authority of India Limited,

Maruti Udyog and also Government of India (for defense and civil debt service).

Large private sector companies like Reliance Group, Tata Group, L & T etc take

active part in foreign exchange market. Of late, the Foreign Institutional

Investors (FIIs) have emerged as a major player in the foreign exchange market

and they do account for noticeable activity in the market.

II. Segments in Foreign exchange Market

The foreign exchange market can be classified into two segments. The merchant

segment consists of the transactions put through by customers to meet their

transaction needs of buying or selling foreign exchange, and inter-bank segment

consists of transactions between banks. At present, there are over 100 ADs operating in the foreign exchange market. The banks deal among themselves

directly or through foreign exchange brokers. The interbank segment of the forex

market is dominated by few large Indian banks with State Bank of India (SBI)

accounting for a large portion of turnover.

III. Market Makers of Foreign exchange Market

The market makers are expected to make a good price with narrow spreads both

in the spot and the swap segments. The efficiency and liquidity of a market are

often gauged in terms of bid-offer spreads. Wide spreads is an indication of an

illiquid market or a one way market or a nervous condition in the market. In the

inter-bank market of Indian foreign exchange market SBI along with a few other

banks may be considered as the market-makers, i.e., banks which are always

ready to quote two-way prices both in the spot and swap segments. In India, the

normal spot market quote has a spread of 0.5 to one paisa, while the swap

quotes are available at 2 to 4 paisa spread. At times of volatility, the spread

widens to 5 to 10 paisa.

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IV. Turnover15

The turnover in the Indian foreign exchange market has been increasing over the

years. As shown in the table below the average daily turnover in the Indian

foreign exchange market which was around 2.4 billion dollars in 1998 has

increased to 38.4 billion dollars in 2007,but it came down to 27.4 billion dollars

in 2010.

Table 4.1. Turnover in Indian Foreign exchange Market16

Year 1998 2001 2004 2007 2010

Amount 2.4 3.4 6.9 38.4 27.4

(Daily Average In billions of USD)

V. Forward Market

As a result of the initiatives of the RBI the forward market in India is active up to

one year where two way quotes are available.

VI. Data on Foreign exchange Markets

The RBI publishes daily data on exchange rates, foreign exchange turnover and

the movement in foreign exchange reserves of the RBI on a weekly basis. The

RBI also publishes data on Nominal Effective Exchange Rate (NEER) and Real

Effective Exchange Rate (REER), RBI's purchases and sales in the foreign

exchange market. Importantly the RBI has been publishing the size of its gross

intervention (purchase and sale) in India’s foreign exchange market.

4.2.2 Maturity of Indian foreign exchange market:

As a rule of thumb, the maturity of a foreign exchange market can be measured

by the ratio of the daily volume traded to the country’s underlying foreign trade

(imports plus exports). A study by Meclai and Shaik (2009) as shown in the

table A6 of Appendix-A, Russia, India and South Africa were the most mature

15 Source: Triennial Central Bank Survey of BIS (Bank for International Settlement) 2010 16 Triennial Central Bank Survey of BIS (Bank for International Settlement) 2010

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of 14 emerging foreign exchange markets studied, using data from the 2007 BIS

survey of central banks. They each scored more than 50 on the Market Maturity

Index (MMI), suggesting they are more than halfway there, as compared to the

fully mature markets, like the US. By that measure, India ranked third, behind

Russia and South Africa, of 14 emerging markets that were studied, using BIS

data for transaction volumes and WTO data for trade volumes. China and Brazil

were far behind, with China ranking last. In fact, total Chinese yuan traded

volumes were only about 25% of INR traded volumes. The Indian market has

been the real killer – the fastest-growing foreign exchange market with a daily

volumes rose from $ 34 billion in April 2007 to $ 53 billion in April 2008, before

falling to $ 44 billion in April 2009. Despite this dramatic growth, there is still a lot

of work to be done before the INR market could be considered highly liquid.

4.2.3. Foreign exchange derivative market in India

Derivative markets worldwide have witnessed explosive growth in recent past. As

per BIS Triennial Central Bank Survey, the average daily turnover in OTC

derivatives segment has increased to $2.5 trillion in April 2010 as compared to

$2.1 trillion in April 2007.

In India, the economic liberalization in the early nineties provided the foundation

for the introduction of Foreign exchange derivatives. With the current account

convertibility being introduced in 1993, the environment became even more

favorable for the introduction of derivative products. Similar to Indian foreign

exchange market, foreign exchange derivative markets have also developed

significantly over the years. As per the BIS global survey average daily turnover

in Indian foreign exchange derivative market as shown in the table below has

increased to 24 billion dollars in 2007 as compared to just 3 billion dollars in 2004

but it has fallen to 14 billion dollars in 2010.

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Table 4.2. Turnover in Indian foreign exchange derivatives Market17

Year Turnover

2001 1 2004 3 2007 24 2010 14

(Average daily turnover in billions of USD)

4.3 Exchange Rate Management in India

Since independence, exchange rate system in India has transformed from fixed

exchange rate regime to market determined exchange rate regime. The following

paragraphs provides the exchange rate management followed in India since

independence.

I. Par value system (1947 – 1971)

After independence India followed par value system of IMF where by exchange

rate was pegged to Pound sterling at Rs 13.33/pound (Rs 4.76/USD). This

remain unchanged up to 1966 when rupee was devalued by 36.5% to Rs

21/pound (Rs7.5/USD). This exchange rate remained until 1971 when Bretton

Wood system came to an end.

II. Pegged Exchange Rate regime (1971-1992)

India pegged its exchange rate to Pound from 1971 to 1975. After realizing the

limitations associated with single currency pegging and declining role of UK in

Indian trade, India pegged its exchange rate to a basket of currencies of India’s

major trading partners in 1975 and this system remained up to 1992. During this

period RBI has officially determined India’s exchange rate within a nominal band

of +/- 5% of weighted basket of currencies of India’s major trading partners. Two

step devaluation of was made in 1991 to the extent of 18-19% to place exchange

rate in line with inflation and to maintain India’s export competitiveness.

17 Triennial Central Bank Survey of BIS (Bank for International Settlement) 2010

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III. Liberalized exchange Rate Regime

On the basis of report of high powered committee on Balance of Payments, in

92-93 Budget, government introduced current account Convertibility which

resulted in adoption of Liberalised Exchange Rate System (LERMS). Under this

system, dual exchange rate was fixed as per which 60% of foreign exchange

earnings were to be converted at a market determined exchange rate and 40%

were to be surrendered at official exchange rate. This was just a transitional

mechanism and was followed by market determined exchange rate regime.

IV. Market Determined Exchange Rate Regime

Also called as Unified exchange rate regime, this exchange rate regime was

introduced in 1993-94 budget. The objectives of this regime are development of

orderly foreign exchange market, maintaining adequate foreign exchange

reserve and reducing excess volatility in foreign exchange market. This market

determined exchange rate regime followed in India since 1993 is a managed float

or dirty float regime. Under this system 100% conversion of foreign exchange

earnings was done at market rate and this conversion was applicable to entire

merchandise trade and all receipts. Exchange control norms of RBI remained all

along and fuller current account convertibility was achieved by 1994 august.

4.4 Exchange Rate Movement in India18

Until the year 1992 India adopted pegged exchange rate mechanism where by

government fixed exchange rate of Indian rupee against the major currencies.

India devalued the rupee as and when it was required. India adopted Unified

exchange rate regime or managed float system since 1993. Table A4 of Appendix-A shows the financial year annual average exchange rate of rupee

against major currencies from 1970-71 to 2010-11 and for more detailed

analysis of volatility, Table A5 of Appendix-A gives monthly average

exchange rate of rupee against major currencies. Report on currency and

18 Reserve Bank of India, Report on Currency and finance, 2002-03, pp203-204 and other RBI reports

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finance 2002-03 divide the period starting from 1993 in to following four sub

periods.

I. March 1993 to August 1995:

Due to positive investors confidence, India experienced a surge in capital inflows

during 1993-94, 94-95 and first half of 95-96. Along with capital inflows and good

export growth put pressure on exchange rate. During this period RBI has

sterilized large capital inflows by timely intervention. During this period exchange

rate remained around Rs31/$.

II. September 1995 to December 1996:

Rupee came under pressure during September 1995 mainly due to slowdown

due to Mexican crisis, widening of current account deficit, rise of USD against

major currencies. Rupee depreciated by almost 9% during September 95 to

October 95 and got stabilized by Feb 96. RBI intervened actively backed by

monetary tightening. In February 96 rupee again depreciated to almost Rs38 per

USD, but timely intervention by RBI restored the exchange rate. In the remaining

part of 1996 rupee was range bound.

III. The period 1997 to 2002:

During this period exchange rate depreciated from Rs33/$ to Rs 48/$. The

reason for such as drastic depreciation is number of internal and external

adverse developments. Internal reason includes, economic sanctions due to

India’s nuclear test, Kargil war in 1999 etc. External developments includes,

contagion due to Asian financial crisis, Russian financial crisis, sharp increase in

crude prices, September 11 attack etc.

IV. The Period 2002 onwards:

Rupee remained range bound during calendar year 2002 and 2003. Rupee

started appreciating against USD and it reached Rs 43.8 by end of 2004.

Volatility of small magnitude continued during 2005 and 2006, but drastic

appreciation of rupee took place in 2007 and exchange rate touched Rs39.3/$

level in December 2007. Depreciation started in the middle of calendar year 2008

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and exchange rate touched a level of Rs 52/$ in early part of 2009. From

beginning to end of financial year 2008-09 rupee has depreciated by over 25%.

The high degree of volatility during this period is attributed to both internal and

external reasons. From January 2010 till middle of 2011 the exchange rate of

Indian rupee against USD remained range bound between Rs 44.5 per USD to

Rs 46.5 per USD.

4.5 Volatility of Indian Rupee in the Recent Past

The main reason for the INR's appreciation since late 2006 has been a flood of

foreign-exchange inflows, especially in the form of US dollars. The surge of

capital and other inflows into India has taken a variety of forms, ranging from

FDIs to remittances sent home by Indian expatriates. Similarly during later part of

2008 when there was an outflow of foreign exchange mainly due to global

recession, the rupee depreciated drastically. Apart from inflow and outflow of

foreign exchange many of the internal and external reasons led to volatility of

Indian rupee. The main reasons for appreciation and later on depreciation of

Indian rupee against major currencies, especially USD are:

I. Foreign Direct Investment (FDI)- India's exceptional economic growth

has created a large domestic market that offers promising opportunities for

foreign investors. Furthermore, the country's increasing competitiveness in

many sectors has made it an attractive export base. These factors led to

FDI inflows into the country.

II. External Commercial Borrowings (ECBs) - Indian companies have

borrowed huge amounts of money from abroad to finance investments

and acquisitions at home and abroad. India's balance-of-payments (BoP)

data reveal that inflows through ECBs is enormous

III. Foreign portfolio inflows -India's booming stock market embodies the

confidence of investors in the country's corporate sector. Foreign portfolio

inflows have played a key role in fuelling this boom. Another major source

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of portfolio capital inflows has been overseas equity issues of Indian

companies via Global Depositary Receipts (GDRs) and American

Depositary Receipts (ADRs).

IV. Investments and remittances -Indians settled in foreign countries have

also been a major source of capital inflows in to India. Many non-resident

Indians (NRIs) are investing large amounts in special bank accounts.

While NRIs' emotional connection to their country of origin and the

attractive interest rates offered on such deposits are the main reasons for

inflow of remittance into India.

4.6 Problem of Currency Exposure in Indian Context

Under Indian context originally, currency exposure was not a problem at all

because parity value of Indian rupee was determined by Government of India. It

remained fixed for very long period of time. Even when parity value underwent a

fluctuation there use to be a continuous depreciation of Indian rupee against

major currencies of the world especially USD. In early nineties, India resorted to

Market determined Exchange rate system. Even after this there was a

continuous depreciation in the parity value of Indian rupee. Since 2003 there

started a trend of appreciation of Indian rupee against major currencies

especially USD. Exchange rate of Indian rupee against major currencies,

especially USD underwent a drastic appreciation in the year 2007 and the trend

was reversed in 2008 when there was a drastic depreciation. In this volatility of

exchange rate Indian Business enterprises which are into overseas operations

faces significant currency exposure.

The major reasons for the emergence of significant currency exposure among Indian business enterprises are as follows

India’s exports19 which was around 18 billion dollar in 1991-92 has crossed 245

billion dollar in 2010-11, similarly India’s imports which was at 19 billion dollar

19 Source : Directorate General of Commercial Intelligence & Statistics, Kolkata

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has crossed 350 billion dollar during the same period. India’s share in world

export which was just 0.5% in 1990 has increased to 1.4%20 by 2010. With the

introduction of LPG policy, there has been a continuous inflow of funds into India

in the form of FDI, FII, borrowings by corporate etc. A total foreign investment

inflow21 which was 103 Million USD in 1990-91 has touched nearly 69,500 million

USD in 2009-10. Inflow of foreign exchange in terms of external debt has also

increased considerably in the recent past. India’s external debt which was 84

Billion dollar in 1991 has crossed 260 billion dollar in 201022. Similarly ECBs

which stood at 10 billion dollar in 1991 has crossed 70 billion dollar in 2010.

As shown in table A4 of Appendix-A, there uses to be a trend of continuous

depreciation of Indian rupee against major currencies. This trend continued even

after introduction of market determined Exchange rate system in 93-94. Since

2003 there started a trend of appreciation of Indian rupee against major

currencies especially USD. Annual average exchange rate of Indian rupee

against USD which was Rs17.5 in 1990 continuously depreciated and touched

Rs 48.5 by 2002. Then started a trend of appreciation of rupee against USD. The

Annual average exchange rate of Indian rupee against USD has appreciated all

the way to Rs 39.3 by the end of 2007. The exchange rate of Indian rupee

remained extremely volatile during 2007 to 2010. This volatility can be examined

by observing the monthly average exchange rate as shown in table A5 of Appendix-A. The monthly average exchange rate of Indian rupee against USD

was Rs 44.2 during Jan 2007 and by May 2007 it was Rs 40.5 marking an

appreciation of 8% within four months during the same period monthly average

exchange rate of Indian rupee against EURO had appreciated by around 5%.

Exchange rate of rupee against USD remained range bound till March 2008 and

then trend of depreciation started between April 2008 to March 2009. During this

period Indian rupee has depreciated by about 28% (From Rs 40 per USD to Rs

51.2 per USD) but the depreciation of Indian rupee against other currencies

20 Source: Reserve Bank of India 21 Source: Reserve Bank of India 22 Source: Reserve Bank of India

97

during the same period is less. From beginning 2010 till middle of 2011 the

exchange rate of Indian rupee against USD remained range bound between Rs

44.5 per USD to Rs 46.5 per USD.

US dollar has been used extensively by Indian business enterprises as a

currency for their foreign operations. During the year 2007-08, 86% of Indian

exports and 89% of imports were invoiced in US dollars23. The Euro was a

distant second, with shares of 8% in exports and 7% in imports. Similarly USD

constitutes a substantial portion of turnover in Indian foreign exchange market.

Out of total turnover of 34,085 million dollar, share of dollar is 32,65024 Million

dollar.

Considerable increase in cross border transactions backed up by extreme

exchange rate volatility has resulted in significant currency exposure for Indian Business enterprises which are into overseas operations.

The impact of exposure of business enterprises to currency volatility has a direct

bearing on their profitability. A report by Edelweiss Capital calculated that the

total foreign exchange-related loss in BSE 100 companies which comprise the

100 most valued companies in India, for the year 2008-09 was a whopping Rs

43,00025 crores.

There are various literatures, surveys, news analysis which analyses the impact

of currency exposure of Indian business enterprises. But unfortunately, most of

these concentrate on impact of rupee appreciation rather than depreciation of

rupee against USD. (The reasons for the same may be that in India when rupee appreciates, it affects exports, media gives more attention to rupee

appreciation problem and lobby by exporters is more than that of importers.)

23 Source: Reserve Bank of India 24 Triennial Central Bank Survey of BIS 2007 25 “Forex losses eat into profits of India Inc”, Economic Times, 12 Dec 2009. http://economictimes.indiatimes.com/Forex-losses-eat-into-profits-of-India-Inc/articleshow/5329283.cms

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Some of the surveys conducted by trade and industry bodies which reveal the Impact of rupee appreciation on the competitiveness and profitability of Indian business enterprises are given below.

A survey by FICCI (June 2007) analyses the impact of rupee appreciation on

Indian manufacturing sector. Among various sectors impacted readymade

garments sector seems to be worst hit. Minimum fall in the level of exports is

reported to be 20 percent and maximum is in the range of 40 to 50 percent.

Rupee appreciation has made garment exporters uncompetitive to the tune of 8

percent to 15 percent in terms of price in the international market. Buyers are

increasingly moving towards neighboring countries like Bangladesh, Pakistan

etc. This will have negative impact on the investments in future. Similarly textile

sector has also seen a fall. It was 25 to 40 percent for many textile exporters in

the month of April & May 2007. Export realizations are down by 6 to 6.5 percent

in some cases. In terms of price, exports are uncompetitive now to the extent of 8

to 10 percent and exports of cotton yarn adversely affected as buyer are

increasingly sourcing from Pakistan. Similarly ASSOCHAM (2007) conducted a

survey of 400 large, medium and small exporters on the adequacy of the

Rs.1400crore export package announced by government to the rupee

appreciation-hit exporters. An overwhelming majority of 80 percent complained

that a 10 percent rise in rupee has rendered the exports proceeds uncompetitive.

Four hundred exporters both small and large were surveyed from diverse export

backgrounds. 80 percent of the exporters surveyed felt that the margins of SMEs

had been wiped out on account of appreciation. FICCI (2004) survey on ‘Impact

of rupee appreciation on Indian exporters’ reveals that more than 73 percent of

the respondents feel that rupee appreciation is a very serious problem. Majority

of the respondents feels that appreciation is putting pressure on revenue and in

turn on margins. The preceding paragraphs indicate the impact of currency exposure (volatility) on

the Indian Business enterprises. What was discussed above is just a tip of an ice

berg. Most of the above news reports, literature and surveys were conducted

relating to listed companies where public reporting of financial statements is

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compulsory, but the impact of currency exposure on unlisted private sector

organizations including SMEs are not accounted for as they are not compelled to

report their financial performance publicly. The impact of problem of currency

exposure is felt on the exports of the country, Direct and Indirect tax collection

etc. Considering the severances of the problem of currency exposure Indian

government has provided the host of facilities to Indian business enterprises to

manage the currency exposure.

4.7 Currency Exposure Management Avenues for Business Enterprises in India

As discussed in preceding chapter, currency exposure can be managed by both

internal and external techniques. Some of the popular internal exposure

management techniques available to Indian business enterprises includes

creating a natural hedge, export financing, risk sharing agreements etc. Apart

from these internal techniques, Indian business enterprises can make use of

host of external techniques which are discussed below. Based on the

recommendations of the Rangarajan Committee on Balance of Payments Indian

business enterprises were given access to various currency derivative

instruments such as foreign exchange forward contracts, foreign currency-rupee

swap instruments and currency options – both cross currency as well as foreign

currency-rupee. In the case of derivatives involving only foreign currency, a

range of products such as IRS, FRAs, option are allowed. Apart from above said

OTC instruments, exchange traded Currency futures were introduced in Aug

2008 and Currency Options was introduced in Oct 2010. The currency exposure

management avenues available to business enterprises in India can be studied

under the following heads.

OTC derivative Instruments offered by RBI

Exchange traded derivative instruments

Exchange Earners Foreign Currency (EEFC) account

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4.7.1 OTC Derivative Instruments offered by RBI

The Reserve Bank of India (RBI), the central bank of the country, is also

entrusted with the management of foreign exchange under the provisions of the

Foreign Exchange Management Act (FEMA). As a regulator under FEMA the

RBI annually issues a risk management circular for the purpose26. The

circular comes with a sunset clause – it is valid only for a year and is replaced by

another circular when it expires. The provisions of the said circular have to be

complied by authorized dealers in foreign exchange. The circular elaborates on

the various derivative tools available in India to manage currency exposure and

various provisions relating to usage of the same. Some of the Products available

to the business enterprises for managing their currency exposure are discussed

below. In case of all these products AD (Authorized Dealer) Category I Banks

act as market makers.

The product/purpose-wise facilities available in India to manage the currency

exposure are discussed under the following heads.

A) Contracted Exposure

B) Probable Exposure

C) Special Dispensation

A. Contracted Exposures

Banks have to confirm the underlying foreign currency exposure of business

enterprises through verification of documentary evidence and should be

satisfied about the genuineness of the underlying exposure, irrespective of the

transaction being a current or a capital account. The products available under

this facility are as follows:

26 Master Circular on Risk Management and Inter-Bank Dealings, July 2011.

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I. Forward Foreign Exchange Contracts: The purpose of this product is

a) To hedge exchange rate risk in respect of transactions for which sale and

/or purchase of foreign exchange is permitted under the FEMA

b) To hedge exchange rate risk in respect of the market value of overseas

direct investments (in equity and loan).

General principles and conditions to be observed for forward foreign exchange

contracts are as follows.

a) The maturity of the hedge should not exceed the maturity of the underlying

transaction. The currency of hedge and tenor, subject to the above

restrictions, are left to the customer.

b) Where the exact amount of the underlying transaction is not ascertainable,

the contract may be booked on the basis of reasonable estimates.

However, there should be periodical review of the estimates.

II. Cross Currency Options (not involving Rupee): The Purpose of this

product is

a) To hedge exchange rate risk arising out of trade transactions.

b) To hedge the contingent foreign exchange exposure arising out of

submission of a tender bid in foreign exchange.

General principles and conditions to be observed while using this product are

as follows.

a) AD Category I banks can only offer plain vanilla European options.

b) Customers can buy call or put options.

c) These transactions may be freely booked and/ or cancelled subject to

verification of the underlying exposure.

d) All guidelines applicable for cross currency forward contracts are

applicable to cross currency option contracts also.

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III. Foreign Currency - INR Options: The Purpose of this product is

a) To hedge foreign currency exposures

b) To hedge the contingent foreign exchange exposure arising out of

submission of a tender bid in foreign exchange.

General principles and conditions to be observed while using this product

are as follows

a) AD Category I banks having a minimum CRAR of 9 per cent, can offer

foreign currency– INR options on a back-to-back basis.

b) At present, AD category I banks can offer only plain vanilla European

options.

c) Customers can buy call or put options.

d) All guidelines applicable for foreign currency-INR foreign exchange forward

contracts are applicable to foreign currency-INR option contracts also.

IV. Foreign Currency-INR Swaps: The Purpose of this product is to hedge

exchange rate and/or interest rate risk exposure for those having long-term

foreign currency borrowing or to transform long-term INR borrowing into foreign

currency liability.

General principles and conditions to be observed while using this product are

as follows

a) No swap transactions involving upfront payment of Rupees or its equivalent in

any form shall be undertaken.

b) The term “long-term exposure” means exposures with residual maturity of one

year or more.

c) Swap transactions may be undertaken by AD Category I banks as

intermediaries by matching the requirements of corporate counterparties. While

no limits are placed on the AD Category I banks for undertaking swaps to

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facilitate customers to hedge their foreign exchange exposures, a limit of USD

100 million is placed for net supply of foreign exchange in the market on account

of swaps which facilitate customers to assume foreign currency liability. Positions

arising out of cancellation of foreign currency-INR swaps by customers need not

be reckoned with in this cap.

V) Hedging of Borrowings in foreign exchange: This facility is provided in

accordance with the provisions of Foreign Exchange Management (Borrowing

and Lending in Foreign Exchange) regulations. Products available for this

purpose are interest rate swap, Cross currency swap, Coupon swap, Cross

currency option, Interest rate cap or collar (purchases), Forward rate agreement

(FRA). Purpose of these instruments is for hedging interest rate risk and

currency risk on loan exposure and unwinding from such hedges

General principles and conditions to be observed while using these product are

as follows

a) The products should not involve the rupee under any circumstances.

b) Final approval has been accorded or Loan Registration Number allotted by

the Reserve Bank for borrowing in foreign currency.

c) The notional principal amount of the product should not exceed the

outstanding amount of the foreign currency loan.

d) The maturity of the product should not exceed the unexpired maturity of the

underlying loan.

e) The contracts may be cancelled and rebooked freely.

B. Probable exposures based on past performance

Users of these products are Importers and exporters of goods and services.

Purpose of these products is to hedge currency risk on the basis of a declaration

of an exposure and based on past performance up to the average of the previous

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three financial years’ (April to March) actual import/export turnover or the

previous year’s actual import/export turnover, whichever is higher. Probable

exposure based on past performance can be managed only in respect of trades

in merchandise goods as well as services. Products available here include forward foreign exchange contracts, cross currency options (not involving the rupee) and foreign currency-INR options.

General principles and conditions to be observed while using these product are

as follows

b) The contracts booked during the current financial year (April-March) and

the outstanding contracts at any point of time should not exceed the eligible

limit i.e. the average of the previous three financial years’ actual import/export

turnover or the previous year’s actual import/export turnover, whichever is

higher.

c) Contracts booked in excess of 75 per cent of the eligible limit will be on

deliverable basis and cannot be cancelled.

d) These limits shall be computed separately for import/export transactions.

e) Higher limits will be permitted on a case-by-case basis on application to the

Foreign Exchange Department, Central Office, Reserve Bank of India. The

additional limits, if sanctioned, shall be on a deliverable basis.

f) Any contract booked without producing documentary evidence will be

marked off against this limit. These contracts once cancelled, are not eligible

to be rebooked. Rollovers are also not permitted.

C. Special Dispensation for Small and Medium Enterprises (SMEs)

Purpose of this product is to hedge direct and / or indirect exposures of SMEs to

foreign exchange risk. Product available under this category is Forward foreign exchange contracts. Small and Medium Enterprises (SMEs) having direct and /

or indirect exposures to foreign exchange risk are permitted to book / cancel /

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rebook/ roll over forward contracts without production of underlying documents to

manage their exposures effectively

General principles and conditions to be observed while using this product is as

follows

a) Such contracts may be booked through AD Category I banks with whom

the SMEs have credit facilities and the total forward contracts booked

should be in alignment with the credit facilities availed by them for their

foreign exchange requirements or their working capital requirements or

capital expenditure.

b) AD Category I bank should carry out due diligence regarding “user

appropriateness” and “suitability” of the forward contracts to the SME

customers.

c) The SMEs availing this facility should furnish a declaration to the AD

Category I bank regarding the amounts of forward contracts already

booked, if any, with other AD Category I banks under this facility.

4.7.2 Exchange traded derivative instruments

Apart from the OTC derivative products discussed above, the business

enterprises can manage their currency exposure with Currency Futures and

Currency Options which are exchange traded in nature. The features of

these products along with the general principles and conditions to be observed

while using these products are as follows

I. Currency futures

Currency futures is one of the important hedging instrument used in developed countries. In order to facilitate the market participants in managing

the exchange rate volatility, RBI set up a joint working committee to explore the

feasibilities of introducing currency futures. Joint working committee of RBI and

SEBI (Securities and Exchange Board of India) finalized the guidelines for

exchange-traded currency futures in April 2008. Based on the guidelines, RBI

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framed the directives on currency futures trading on recognized stock exchanges

and new exchanges. Since August 2008 currency futures was introduced in

India.

Gist of RBI Guidelines for Exchange-Traded Currency Futures in India:27

Currency futures are permitted in US Dollar (USD) - Indian Rupee

(INR), Euro (EUR)-INR, Japanese Yen (JPY)-INR and Pound

Sterling (GBP)-INR.

Only ‘persons resident in India’ may purchase or sell currency

futures contracts to hedge an exposure to foreign exchange rate

risk or otherwise.

The size of each contract shall be USD 1000 for USD-INR

contracts, Euro 1000 for Euro-INR contracts, GBP 1000 for GBP-

INR contracts and JPY 100,000 for JPY-INR contracts.

The contracts shall be quoted and settled in Indian Rupees.

The maturity of the contracts shall not exceed 12 months.

The settlement price for USD-INR and Euro-INR contracts shall be

the Reserve Bank’s Reference Rates and for GBP-INR and JPY-

INR contracts shall be the exchange rates published by the

Reserve Bank in its press release on the last trading day.

Membership of currency futures market has been kept separate

from equity markets.

Trading and clearing membership shall be issued as per the

guidelines of SEBI.

27 Master Circular on Risk Management and Inter-Bank Dealings, July 2011.

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II. Currency Options 28

In order to expand the existing menu of exchange traded hedging tools, since

Oct 2010 plain vanilla currency options contracts have been permitted to be

traded in recognized stock exchanges or new exchanges, recognized by the

Securities and Exchange Board of India (SEBI) in the country. Exchange traded

Currency options are subject to following conditions:

Exchange traded Currency option contracts are permitted in US Dollar

(USD) - Indian Rupee (INR).

Only ‘persons resident in India’ may purchase or sell exchange traded

currency options contracts to hedge an exposure to foreign exchange rate

risk or otherwise.

The underlying for the currency option shall be US Dollar – Indian Rupee

(USD-INR) spot rate.

The options shall be premium styled European call and put options.

The size of each contract shall be USD 1000.

The premium shall be quoted in Rupee terms. The outstanding position

shall be in USD.

The maturity of the contracts shall not exceed twelve months.

The contracts shall be settled in cash in Indian Rupees.

The settlement price shall be the Reserve Bank’s Reference Rate on the

date of expiry of the contracts.

Members registered with the SEBI for trading in currency futures market

shall be eligible to trade in the exchange traded currency options market

of a recognised stock exchange.

28 Master Circular on Risk Management and Inter-Bank Dealings, July 2011.

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Exchange traded currency derivatives and Regulatory Framework in India

Hitherto, foreign exchange trading in India was under the regulatory control of

RBI but, Currency futures and exchange traded currency options are

considered as securities as defined under Securities Contracts (Regulation) Act,

1956 and thus governed and regulated by SEBI under SCR Act, 1956.

After the introduction of currency futures and Options trading in India, now there

are two regulatory agencies RBI and SEBI (Securities and Exchange Board of

India). Foreign exchange is under the regulatory control of RBI under Foreign

Exchange Management Act, 1999 (FEMA) and Currency futures and exchange

traded currency Options are under the regulatory control of SEBI. In order to sort

out the issues arising out of overlapping of jurisdiction of currency futures, SEBI-

RBI joint committee has been formed for overall coordination purposes. RBI has

amended FEMA regulations, 2000 by Foreign Exchange Management (Foreign

Exchange Derivatives Contracts)(Amendments) Regulations, 2008.

4.7.3 Exchange Earners Foreign Currency (EEFC) account:

Apart from derivative products discussed above, Indian business enterprises

have access to EEFC account which helps in protecting themselves from

exchange rate fluctuations. The EEFC account is a special type of current

account aimed at exporters who receive eligible remittances in foreign currency

as per FEMA regulations. The account is maintained in foreign currency,

shielding accountholders from exchange rate fluctuations.

A person resident in India is permitted to open and maintain this account with an

authorized dealer in India. EEFC account is permitted to be maintained in the

form of non-interest bearing current accounts. In view of the recent global and

domestic developments and with a view to give an opportunity to small and

medium enterprises to manage the challenges in the global markets, Reserve

Bank of India has permitted the banks to give interest on EEFC accounts.

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Features & benefits

Zero balance account, so no need to maintain any average or minimum

balance in the EEFC account

Available in four currencies: US Dollars, Japanese Yen, Pound Sterling

(GBP) and EURO

Comprehensive range of Doorstep banking services

Wide range of trade services available at attractive rates on this account.

4.8 Accounting Aspects of Currency Exposure Management29

The accounting aspects of currency exposure management in India are

significantly influenced by the accounting standard issued by the ICAI (Institute of

Chartered Accountants of India). The policy of a Liberalized Exchange Rate

Mechanism (LERMs) and the partial convertibility of the rupee announced by the

Government in March 1993, led the ICAI to came out with standard AS 11:

'Accounting for the effects of changes in Foreign Exchange Rates.' and it is made

mandatory for all limited companies in India. Accounting Standard AS 11 (revised

2003) has been issued by the ICAI replacing AS 11 (1994). Some of the basic provisions of AS 11 is provided below followed by comparison of As 11 with

(International Accounting Standard) IAS 21: ‘The Effects of Changes in Foreign

Exchange Rates’.

4.8.1 Provisions of AS11: Effects of changes in Foreign Exchange Rates

Some of the basic provisions of accounting standard 11 issued by ICAI are given

below.

The principal issues in accounting for foreign currency transactions and

foreign operations are to decide which exchange rate to use and how to

recognise in the financial statements the financial effect of changes in

exchange rates. 29 Source: www.icai.org

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The Statement is applied in accounting for transactions in foreign currency

and translating financial statements of foreign operations. It also deals

with accounting of forward exchange contract.

Initial recognition of a foreign currency transaction shall be by applying the

foreign currency exchange rate as on the date of transaction. In case of

voluminous transactions a weekly or a monthly average rate is permitted,

if fluctuation during the period is not significant.

At each Balance Sheet date foreign currency monetary items such as

cash, receivables, and payables shall be reported at the closing exchange

rates unless there are restrictions on remittances or it is not possible to

effect an exchange of currency at that rate. In the latter case it should be

accounted at realisable rate in reporting currency. Non monetary items

such as fixed assets, investment in equity shares which are carried at

historical cost shall be reported at the exchange rate on the date of

transaction. Non monetary items which are carried at fair value shall be

reported at the exchange rate that existed When the value was

determined. Note: Schedule VI to the Companies Act, 1956, provides that

any increase or reduction in liability on account of an asset acquired from

outside India in consequence of a change in the rate of exchange, the

amount of such increase or decrease, should added to, or, as the case

may be, deducted from the cost of the fixed asset. Therefore, for fixed

assets, the treatment described in Schedule VI will be in compliance with

this standard, instead of stating it at historical cost.

Exchange differences arising on the settlement of monetary items or on

restatement of monetary items on each balance sheet date shall be

recognised as expense or income in the period in which they arise.

Exchange differences arising on monetary item which in substance, is net

investment in a non integral foreign operation (long term loans) shall be

credited to foreign currency translation reserve and shall be recognised as

income or expense at the time of disposal of net investment.

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The financial statements of an integral foreign operation shall be

translated as if the transactions of the foreign operation had been those of

the reporting enterprise; i.e., it is initially to be accounted at the exchange

rate prevailing on the date of transaction.

For incorporation of non integral foreign operation, both monetary and non

monetary assets and liabilities should be translated at the closing rate as

on the balance sheet date. The income and expenses should be

translated at the exchange rates at the date of transactions. The resulting

exchange differences should be accumulated in the foreign currency

translation reserve until the disposal of net investment. Any goodwill or

capital reserve on acquisition on non-integral financial operation is

translated at the closing rate.

In Consolidated Financial Statement (CFS) of the reporting enterprise,

exchange difference arising on intra group monetary items continues to be

recognised as income or expense, unless the same is in substance an

enterprise’s net investment in non integral foreign operation.

When the financial statements of non integral foreign operations of a

different date are used for CFS of the reporting enterprise, the assets and

liabilities are translated at the exchange rate prevailing on the balance

sheet date of the non integral foreign operations. Further adjustments are

to be made for significant movements in exchange rates upto the balance

sheet date of the reporting currency.

When there is a change in the classification of a foreign operation from

integral to non integral or vice versa the translation procedures applicable

to the revised classification should be applied from the date of

reclassification.

Forward Exchange Contract may be entered to establish the amount of

the reporting currency required or available at the settlement date of the

transaction or intended for trading or speculation. Where the contracts are

not intended for trading or speculation purposes the premium or discount

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arising at the time of inception of the forward contract should be amortized

as expense or income over the life of the contract. Further, exchange

differences on such contracts should be recognised in the P & L A/c in the

reporting period in which there is change in the exchange rates. Exchange

difference on forward exchange contract is the difference between

exchange rate at the reporting date and exchange difference at the date of

inception of the contract for the underlying currency.

Profit or loss arising on the renewal or cancellation of the forward contract

should be recognised as income or expense for the period. A gain or loss

on forward exchange contract intended for trading or speculation should

be recognised in the profit and loss statement for the period. Such gain or

loss should be computed with reference to the difference between forward

rate on the reporting date for the remaining maturity period of the contract

and the contracted forward rate. This means that the forward contract is

marked to market. For such contract, premium or discount is not

recognised separately.

Disclosure to be made for:

Amount of exchange difference included in Profit and Loss statement.

Net exchange difference accumulated in Foreign Currency Translation

Reserve.

In case of reclassification of significant foreign operation, the nature of

the change, the reasons for the same and its impact on the

shareholders fund and the impact on the Net Profit and Loss for each

period presented.

Non mandatory Disclosures can be made for foreign currency risk

management policy.

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4.8.2 Comparison of AS 11 with IAS 21 The Effects of Changes in Foreign Exchange Rates (revised 1993)

Revised AS 11 (2003) differs from International Accounting Standard (IAS) 21,

The Effects of Changes in Foreign Exchange Rates, in the following major

respects in terms of scope, accounting treatment, and terminology.

I. Scope (Inclusion of forward exchange contracts): Revised AS 11 (2003)

deals with forward exchange contracts both intended for hedging and for trading

or speculation. IAS 21 does not deal with hedge accounting for foreign currency

items other than the classification of exchange differences arising on a foreign

currency liability accounted for as a hedge of a net investment in a foreign entity.

It also does not deal with forward exchange contracts for trading or speculation.

The aforesaid aspects are dealt with in IAS 39, Financial Instruments:

Recognition and Measurement. Although, an Indian accounting standard

corresponding to IAS 39 is under preparation, it has been decided to deal with

accounting for forward exchange contracts in the revised AS 11(2003), since the

existing AS 11 deals with the same. Thus, accounting for forward exchange

contracts would not remain unaddressed until the issuance of the Indian

accounting standard on financial instruments.

II. Accounting treatment Recognition of exchange differences resulting

from severe currency devaluations: IAS 21, as a benchmark treatment,

requires, in general, that exchange differences on transactions be recognized as

income or as expenses in the period in which they arise. IAS 21, however, also

permits as an allowed alternative treatment, that exchange differences that arise

from a severe devaluation or depreciation of a currency be included in the

carrying amount of an asset, if certain conditions are satisfied. In line with the

preference of the Council of the Institute of Chartered Accountants of India, to

eliminate alternatives, where possible, revised AS 11 (2003) adopts the

benchmark treatment as the only acceptable treatment.

III. Terminology Foreign operation: The revised AS 11 (2003) uses the terms,

integral foreign operation and non-integral foreign operation respectively for the

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expressions "foreign operations that are integral to the operations of the reporting

enterprise" and "foreign entity" used in IAS 21. The intention is to communicate

the meaning of these terms concisely. This change has no effect on the

requirements in revised AS 11 (2003). Revised AS 11 (2003) provides additional

implementation guidance by including two more indicators for the classification of

a foreign operation as a non-integral foreign operation.

4.9 Supportive Measures by the Government

India’s progress in terms of exporting goods and services has been remarkable

since the mid-1990s, especially compared with India’s position in the early

1990s. In the interest of the country’s trade in the international arena

Government of India has been coming out with export promotion measures.

Apart from providing export incentives, the government has been monitoring the

situation arising out of the appreciation of rupee. Whenever there was a the rapid

appreciation of rupee (especially during 2007 and 2008) it has adversely

affected exporters. Keeping this in mind, government had announced a set of

supportive measures aimed at providing relief to exporters. These supportive

measures were temporary in nature. Some of these supportive measures are

listed below30.

Refund/ exemption of service tax to exporters in respect of various

services availed for export purposes. Some of those services include

Port Services, Transport of Goods, Transport by Railways, and other port

service general insurance service, technical testing and analysis service,

technical inspection and certification service).

Provision to pay of Interest on Exchange Earners Foreign Currency

(EEFC) accounts. Interest was permissible on outstanding balances to

the extent of US$ 1 million per exporter and rate of interest was

determined by the banks. The interest was paid from October 2007 till

October 31, 2008. 30 Source: Various issues of Economic Times

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Reduction in the interest rate on pre-shipment and post-shipment credit

availed by exporters. The applicable interest rate on pre-shipment credit

up to 180 days and post-shipment credit up to 90 days was BPLR minus

2.5%. In July 2007, the government had announced a reduction of this

maximum rate to BPLR minus 4.5% in respect of the outstanding amount

There was an upward revision in DEPB rates. Apart from that duty credit

scrips of export promotion schemes, as well as the duty entitlement

passbook scheme (DEPB), were issued to exporters as soon as they

produce the shipping bill. Earlier, exporters were required to submit bank

realisation certificates, which come 10 to 12 months after the export

consignments are sent. Exporters who get credit under the Duty

Entitlement Pass-Book Scheme were able to use the same for paying duty

on import of restricted items as well. Earlier, the DEPB credit could be set-

off against import of those items which are allowed without restrictions.

4.10 The status of Currency Exposure Management in India

The preceding sections of the chapter discuss the existence of problem of

currency exposure and avenues available to manage the same. Although Indian business enterprises involved in overseas activities are actively managing their currency exposure, it is not taken up with the seriousness which it deserves. The following literatures indicate the same.

Bijoor (2004) opines that presently, barring a handful of big corporate treasuries,

most of the clients are not giving due importance to their forex exposure and are

not aware of the risk it could pose, if not managed properly. They use cash

market for conversion of their foreign exchange requirement. An E&Y (2007)

survey on corporate treasury reports that forex risk management practices

among the corporates are short-sighted with hedging horizon generally being

less than three years. The findings further reveal that corporate hedging

exercises were largely within a 12-month band with 33 percent resorting to

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‘opportunistic’ hedging. While forwards and currency swaps are still the most

commonly used instruments, as many as 44 percent of the corporates have

growing exposures to exotic structures. The independent survey, covering 34

large companies across India, found that while around 85 percent of the

respondents had a separate treasury operation, most said that their treasury

division was nothing but a cost centre. The study, which covered companies in

several industries, said that except for regulatory compulsion, the forex risk

management practices of most Indian companies are still short-sighted. A Mecklai and Business Standard (2007) survey says most Indian companies

are still quite far from having good risk management processes. Some of this

may have to do with the fact that it is only recently -- say, the last four or five

years -- that the forex market has started throwing up surprises in terms of two-

way movements. Again, it is only recently that many companies have come to

realise that they are, indeed, on their own in the global market and need to create

systems that will protect them when things get rough. Only 17 companies out of

45 taken part in the survey identify exposures for risk management on the date of

the contract; in all other cases, it is later - either on the date of invoice or on the

date the exposure is reported to the treasury. This suggests that in the majority of

companies, risk is identified very late in the game. Twenty-seven companies

used only forwards as hedging instruments and nine used the entire gamut of

instruments, including structured products. The responses showed, however,

that only four of these nine companies have documented risk management

policies. FICCI (June 2007) Survey on exports conducted during 2007 reveals

that while the adverse movement in the country’s exchange rate is affecting

a significantly high 75 percent of the participating companies, just about 30

percent of the participating companies have put in place or have resorted to

a mechanism that provides cover for currency exposure. Further, 82 percent

of the companies reported that in their agreements with their clients they do

not have a clause that allows revision of rates in case of a sizable adverse

movement in the exchange rate. Exporters are also on the lookout for clients

and markets where Euro could be replaced as a medium of exchange for

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US$. Many exporters are also trying for a complete shift in the medium of

exchange from USD to Euro in their existing contracts. Several companies

have already started engaging their international clients and are negotiating

an upward revision in the prices for their products – a task, which they say,

is extremely difficult.

4.11 Conclusion

The gradual liberalization of Indian economy and dismantling of trade barriers

has resulted in considerable inflow of foreign capital into India and integration of

domestic economy with world economy. The daily turnover in the Indian foreign

exchange market which was around 2billion dollars in 1998 has increased to 34

billion dollars in 2007. Similarly the share of India in world market has increased

from 0.1% to 0.9% during the same period. With the globalization risk

management using foreign exchange derivatives products has become a

necessity in India. As per the BIS global survey average daily turnover in Indian

foreign exchange derivative market has increased to 24 billion dollars in 2007 as

compared to just 3 billion dollars in 2004.

The Reserve Bank of India (RBI), the central bank of the country, is entrusted

with the management of foreign exchange under the provisions of the Foreign

Exchange Management Act (FEMA). Aligning its role as regulator, RBI has

introduced different exposure management tools which assist the business

enterprises to manage their currency exposure. Apart from this, government is

providing tax and non tax based relief measures especially when rupee

appreciates against major currencies, USD in particular. It is agonizing to note

that in spite of existence of currency exposure and availability of different

exposure management tools. Indian business enterprises are not making

effective utilisation of the same to manage their currency exposure.