Bernanke’s decision to postpone tapering has opened an escape hatch for Indian companies and policymakers.
September 22, 2013:
Remember the familiar climax scene in the Bollywood movie where the hero is hanging off the edge of a precipice, the villain is making menacing sounds and suddenly, the frail leading lady stuns the villain with a stout stick? This gives the hero the two minutes he needs to save the world.
India has won a very similar reprieve from Ben Bernanke’s decision last week to put off the US Fed’s dreaded ‘tapering’. Had Bernanke gone ahead and wound down bond purchases, India would surely have faced sizeable foreign fund outflows. This would have sparked off a fresh slide in the rupee, battered markets and pushed the country to the brink of a balance of payments crisis.
That’s why the markets celebrated the decision on tapering with such gusto last week, the Sensex rising by 700 points after the announcement. The rupee, already responding to recent ministrations by the RBI, has pulled back to 62, defying dire predictions that it would slip to 70 before too long.
But this is not the time for back-slapping; it is one for swift action. It is important to remember that Bernanke has only postponed the wind-down of stimulus. There is no doubt that it will eventually begin, even as early as December this year.
That gives India about three months’ time to fix everything that is wrong with the economy, the trade balance and corporate finances. There’s plenty to do for everyone.
INDIA INC, HEDGE AND DE-LEVERAGE
Let’s start with India Inc. In recent months, as the rupee went into a tailspin and the economy slowed to a crawl, corporate chieftains have spent much of their time in hand-wringing and discussing the ‘policy paralysis.’ But the truth is that companies have been gripped by a fairly debilitating paralysis of their own.
For one, despite taking rising recourse to foreign currency loans, companies have done very little to hedge their balance sheets against currency risk. In the last five years, while the going was good, many companies replaced rupee debt with dollar loans merely because they offered lower interest rates. But most of them eschewed hedging the currency risk on these exposures, to save on costs.
Then, there are the companies with large import bills who have not just increased their reliance on imports, but have also failed to seek protection against currency risks. Strangely enough, while Indian exporters have been quick to lock into fixed currency contracts on their dollar revenues, large importers have been reluctant to take similar covers to protect against spiralling costs.
It is these lax risk management practices, encouraged further by the accounting freedom to keep mark-to-market losses off the quarterly results, which have wrought much of the recent damage on profit margins and the debt servicing ability of Indian companies.
A recent report by Fitch India Ratings noted that, of the 290 companies on its rating radar, as many as 223 were exposed to currency risk. Yet only 94 hedged their currency exposures. A survey of risk management practices of leading companies by KPMG had a similar story to tell. It noted that while three-fourths of the companies had a ‘risk management policy’, about 43 per cent of them did not satisfactorily implement it.
And where the treasury department did hedge currency exposures, it relied mainly on predictions of market gurus and was wary of betting against market direction!
With the rupee pulling back from 68 to 62, this is just the time for corporate India to shake off its inertia and right all these wrongs.
Large importers should use this window of opportunity to hedge their import bill, no matter if the timing is not exactly right. Companies with sizeable foreign currency loans can seek risk cover, or better still, replace these loans with domestic debt. Come December, the dollar could very well begin to rise once again and global interest rates head northwards.
In fact, this is a good time for all those debt-heavy corporate groups to de-leverage their balance sheets too. Short-term borrowing rates have declined over 200 basis points in the last couple of weeks and the Sensex is back at 20,000 levels. What better opportunity could there be to replace some debt with equity?
POLICYMAKERS, WALK THE TALK
Of course, the postponing of tapering offers a good window of opportunity for policymakers too.
First and foremost, the turn in sentiment can be used to build up the country’s badly depleted foreign exchange reserves. Apart from outright purchases of the dollar by RBI and NRI deposit schemes to shore up the kitty, policymakers must act to repair all the bad press that India has got in recent times.
This could start with walking the talk on foreign direct investments (FDI). While FDI in several sectors, including airlines and retail, has been opened up in rapid-fire fashion, hardly any money has so far come in through this route. This is because different arms of the government have taken perverse pleasure in tying up the aviation and retail FDI proposals in yards of red tape.
Now that a global liquidity squeeze has been put off for three more months, there is a brief window of opportunity available to attract foreign capital.
This requires a drastic change in the regulatory mindset from a tentative ‘Should we really allow foreign investors?’ to a decisive “Let us lay down the welcome mat for them’. If we need to ward off a payments crisis, there isn’t much choice in the matter.
Two, what we need is a structural solution to reducing the trade deficit. So why not stop the witch-hunting on imports and evaluate how exports can be bumped up to take advantage of the strengthening global recovery? More low-cost financing options for exporters and even exemption from minimum alternate tax for those making high value-added exports can be considered.
Finally, the prevailing high interest rates and the perky Sensex also offer policymakers the rare opportunity to woo retail investors back to financial savings. To any investor taking stock of returns from various asset classes today, gold would look particularly unappealing, with its 8 per cent decline in the last one year. In contrast, bank deposits are offering 9-10 per cent and the Sensex is up 12 per cent in one year.
With the tables turned on gold for the first time in five years, there could be no better opportunity to promote mutual funds, sovereign debt, infrastructure bonds or the national pension scheme.
So, the heroine has done her bit in the climax sequence and the villain is reeling from the blow. This is no time for celebrating. It is the time to clamber back quickly and do what needs to be done, to save the day.
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