The Telegraph
Since 1st March, 1999
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Alert on unhedged corporate borrowings

Mumbai, April 29: The Reserve Bank of India (RBI) today cautioned companies against unhedged borrowings of their foreign currency exposures. Such borrowings have been cited as a major reason for the downward movement of forward market premia on the dollar.

In the monetary and credit policy, the RBI noted that the sharp downward movement in forward premia has occurred because, at present, there seems to be a rush to sell dollars in the forward market by exporters and other entities in anticipation of further appreciation of the rupee vis-à-vis the dollar.

In response to this, there is also a rush to “borrow” dollars (for repayments later) and convert these into rupees now. If the rupee does appreciate, the borrowers of dollars expect to make a financial gain (as fewer rupees would be required to repay the “borrowed” dollars). This phenomenon is also reflected in banks going “short” on dollars during intra-day and inter-day foreign currency trades, the RBI noted.

The bank added that while demand for borrowing dollars for repayments later is strong, for the same reason, the demand by companies and others for purchasing dollars in exchange of rupees in the spot and forward markets has become weaker.

This has resulted in companies and other market participants having larger unhedged exposures on their future dollar obligations. It has also led to some postponement of forward demand for dollars. These two phenomena, of higher incentive to sell or borrow dollars and lower demand for actual purchase of spot or forward dollars have put pressure on the forward premia.

The Reserve Bank said that it has received various suggestions from banks and other market participants to meet the demand for borrowed dollars, arising from expectations of a rising rupee. Here, it has been urged that banks should be permitted a higher level of foreign borrowings, and/or higher inflows of foreign currency deposits should be encouraged by increasing the ceiling interest rate on FCNR deposits.

RBI said that while it will continue to operate in the spot and forward markets as per its foreign exchange management policies, it is not in favour of increasing the unhedged borrowings by companies and short-term forex liabilities of banks in order to meet the demand for borrowed dollars that is arising from expectations regarding future movements in dollar-rupee exchange rate.

The central bank, therefore, clarified that at present, while there is an excess supply of dollars in both the spot and forward markets to meet all genuine transactions and investment demand by companies, banks and others, one-way expectations of exchange rate or premia may not always be fulfiled.

“It is of utmost importance, particularly in relatively thin developing country markets, that foreign currency exposures by companies and others are largely hedged or covered against anticipated foreign currency earnings. It may be recalled that a part of the problem that many emerging economies have faced in the past has been due to excessive unhedged foreign currency exposures,” RBI added.

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