Cos Should Hedge At least 63% of ECB Exposure: RBI Paper

Inadequate hedging against wild currency swings has emerged as a major risk for Indian companies borrowing overseas, with a central bank –issuers and long-raisers to buy covers for more than three-fifths of their financing exposure.

The ideal position would be to have at least 63% of total exposure of the External Commercial Borrowing (ECBs) hedge at the system level, a research note from a central bank economist said. Rules are, however, still evolving. All categories of borrowers are not mandated 100% hedging, though banks are.

“In times of typical high forex volatility, firms issuing ECBs may take recourse to hedging their exposure financially/naturally in the range of 63-66%, which would translate to the total cost loan, including hedging cost, proportional to nearly 9% Moreover, this strategy is likely to lead to protection against forex risk,” said a research paper by Ranjeev, assistant director at the Reserve Bank of India’s (RBI) department of statistics and information management.

The study assumes significance as the rupee is expected to weaken through the course of Fed tightening and a surge in dollar demand as crude and commodity price head north.

“Hedging all FX exposures in their entirety may not be optimal in the sense that with fully hedged FX exposure, the benefit of low-cost access to foreign capital is foregone and at the same time unhedged foreign currency exposures may lead to correlated defaults in debt servicing triggering build-up of systemic risk,” the author said.

ECBs at $219 billion comprise a third of India’s external debt as of September. But there are no estimates of the level of hedging as rules are sector specific or tenor specific.

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