About Currency Risk Management-Export Transaction

By Bhadresh Bundela


Exchange rates of major currencies are fluctuating, in highly unpredictable manners under the influence of demand and supply forces. Sometimes market witnesses very high percentage of change in exchange rates in short periods. Adverse movements in exchange rate have potential to eliminate profit factor from the export transaction.
Each exporter, invoicing in foreign currency, with condition to receive payment in future has Transaction Exposure. This process has transferred the currency risk from the foreign buyer to the exporter. Normally exposure period starts with conversion of Rupee cost to sale price in foreign currency. Terminates, when actually export sale proceeds are credited to current a/c of the exporter by the bank.
Exchange rates of foreign currency during the exposure period may change in favour or against the interest of the exporter. Covering, the foreign exchange risk due to adverse change in exchange rates, is termed as hedging the currency risk. If exporter does not want to hedge the currency risk it means that view has been taken that future movement of exchange rates will be in favour of the exporter. Depending on such views may lead to heavy losses due to adverse movements in exchange rates.
Management of Currency risk in export-trade transaction depends on factor as appended below:
• Nature of Invoice Currency
• Amount of Currency
• Exposure Period
• Hedging Instruments
• Selection of Bank’s Branch
• Hedging System
Nature of Invoicing Currency
Selection of invoice currency not only shifts the risk to exporter but also bring the responsibility of managing currency exposure. Exports in USD, exposes to currency risk due to adverse movements of USD/INR exchange rates only, during the exposure period. Whereas, invoice in non-USD exchange rates in Indian forex markets & second changes in USD/ EURO exchange rates in international forex markets during the exposure period.
Exporter should note that foreign currency for its trade transaction, at any point in time, will fall in one of the following market conditions:
a. Strengthening Trend With Forward Premiums
Both the factors are in favour of the Exporter. With Passage of time market will produce better exchange rates for exporters. Hedging policy may be to wait and watch. Wait till exchange rates and forwards margins are moving in the favour of the exporter. Cover the exposure on reversal of the exchange rates trend in consultation with banker/forex expert.
b. Weakening Trend With Forward Discounts
Both the factors are against the business interest of the Exporter. Hedge the exposure immediately. Delays may lead to avoidable losses. Banks provide free consultant service and share the forex market information with suggestions.
c. Uncertain Trends
Selective hedging strategy in uncertain exchange rate movements has been found to be profitable. Some portion of the exposure, based on short term forecasting, is covered and balance is retained as uncover.
The portion of covered and uncovered exposures are changed by cancellation and rebooking the hedge depending upon short-term exchange rate changes. Quantum & timing of hedge is based on forex market condition & forecasting by the experts.
Bank is the cheap and best source of understanding market trends and provide support for risk cover operations. Exporter should try to conduct business in strong currency.
Amount of Exposure
Banks provide card exchange rates for small amount transactions. These rates are calculated by loading heavy margins and are adverse for exporters. Bank quotes better exchange rates based on ongoing market rates for higher amount export transaction. In case of market lots transaction, exporter gets market rate loaded by a few paisa only. Better rate creates more cash flows for exporters.
Exporter should negotiate with banker in each export transaction, for Better exchange rate based on ongoing market rate. Avoid where ever possible, the application of banks’ card rates.
Exposure Period
Normally exposure period starts with converting of Rupee cost to foreign currency sale’s price, covering following activities/stages and ends with receipt of Rupee payment in bank’s account.
EXPOSURE PERIOD FOR EXPORT TANSACTION
Exporter should note carefully that Exposure Period is longer than tenor of the export bill or credit offered to Foreign Buyer. Longer the Exposure Period higher the Uncertainty and Currency Risk.
In case invoiced foreign currency is on Premium against Rupee, take the benefit of higher exchange rate than spot rate offered by banks. Longer the period of credit, better is the exchange rate for exporter.
Long period, export receivable in case of premium currency must be hedged to avoid uncertainties & loss due to adverse movement of exchange rate during exposure period. Some exporter hedge the exposure risk, when they get better rate than forward exchange rate available on date of conversion of costs to foreign currency sale’s price.
Monitoring of exchange rate movements during exposure period also provide an opportunity to earn extra profits by obtaining and lifting the hedge depending upon exchange rate trends.
From experience, it has been observed that exporters may cover exposure on Fridays, last weekdays of fortnight or month end to get better exchange rates. Usually there is heavy demand for US in these days causing upward trend in exchange rates & good timing for exporters to cover the risk.
Hedging Instruments
Various hedging instruments traded on the counter and at the exchange houses are available for hedging the Currency Risk. Selection of hedging instrument for exports depends upon availability, flexibility & cost. The most common and exporter friendly hedging instrument in India is Forward Purchase Contract offered by the banks.
Forward Purchase Contract
Banks provide on the counter derivative, Forward Purchase Contract for Exporters. Forward Purchase Contract is a firm agreement by the exporter to deliver fixed amount of Foreign Currency at future date at prior & fixed exchange rate. It is a firm and binding contract Banks do not charge any upfront commission and book the contract, from very small amount to large amounts. Only very small handling charges approx. Rs. 250 per Contract is charged irrespective of the amount.
Exporter should take uncertainties pertaining to exchange rates movements as a Threat to Profit and transfer the currency risk to Bank by booking forward purchase contract. During the cover period exchange rates may move against the interest of the Exporter but it will get the contracted rate.
Main defect of forward Contact is that exporter is denied to take the benefit of favourable exchange rate movement during covered period.
Booking of Forward Contract
1. Only bank’s customers are eligible for booking the forward contracts.
2. Forward Contracts are offered by the banks for expected export proceeds already made or be made. Where shipment is already made, forward contract shall be booked on the basis of export bills tendered to banks. In other cases, forward contacts are booked on the basis of the track record of the exporter.
3. Choice of currency and tenor of exposure period are left to requirement/decision of the exporter. Further, maturity of the cover period should not exceed the maturity of the export transaction. The maturity of export bills is calculated as under:
4. Cover Period=Period of Usance + Normal Transaction Period + Grace Period (if any)
5. Exporters are permitted to split the hedging to cover the exposure partially and balance to remain uncovered.
6. Exporter is permitted to book forward contract with fixed date or option period delivery of foreign exchange amount. Maximum option period of one month is given that too in last month.
7. Exporter is free to foreclose the Forward Contract at any time before maturity. Any loss or gain will be passed on to the exporter. Some exporter have developed expertise in booking, cancelling & rebooking of forward contacts to generate extra cash flows.
8. Forward purchase contracts may be freely booked, cancelled any time before maturity, rolled over at the ongoing markets without any restrictions.
9. Exporters are permitted to transfer the exchange risk to third currency with objective to achieve better exchange rates. An exporter having receivable in EURO may use the third currency Yen for hedging the currency risk. Third currency hedge and currency/INR hedge may be cancelled and rebooked as per requirements.


Selection of Bank’s Branch
Success of an Exporter depends upon the right choice of the Branch of the Bank. Exporter should select a branch of the bank which is authorised to deal in foreign exchange business or international banking division. Branch should have trained, experienced staff with SWIFT address and facility.
Develop professional relations with forex merchant dealer appointed in branch or forex dealer of the bank. Visits to them will make exporter more wise and professional. Negotiate for better rate based on ongoing market exchange rates for each export transaction. Bring cases of delayed export payments and better exchange rates offered by other banks to improve upon these services by your bank. Market competition will bring good results for your efforts. Bankers, normally take the benefit of knowledge gaps of exporters, especially in the area of quoting better exchange rates for exports.
Best branch of the bank to deal with is “A” category branch in Metropolitan city with SWIFT facility & having best-feedback form exporters.
Hedging Systems
Export organisation depending upon the resources, must develop some hedging system. Such system will help in monitoring the exchange rate movements and to take timely hedge actions. It is found from the experienced of exporters that even spending 15 to 20 minutes a week, spending on scanning of currency rates will create more profits from export business.
For developing, currency risk management strategies and skills to take timely hedging action, following reports have been found to be useful:
Daily Scan Reports of Exchange Rates
Prepare daily scan report with the help of the information obtained from your bank or inputs available in daily financial newspapers. Give the responsibility to junior official in your organisation to prepare it on daily basis. Exporter may analyse on daily or weekly basis, this report to find out the trend or factors affecting exchange rates of the currency in which you are or may be exporting in near future.
Exporters have to study & understand the markets and factor affecting exchange rates. Expertise has to be developed in risk management to take right hedging decision at right time & to secure better exchange rate to improve cash inflows Watch trade & political news, monitor economical & fiscal policies of the major countries of the world & also those of countries in whose currency exporter do business.
Daily scan report will help in developing currency view and timing of taking hedging decisions
Brief Market Comments
Mainly covering the factors influencing the exchange rate of currencies in the local and foreign markets.
Monthly Risk Report
Monthly risk report should contain the information currency wise covering projections of export & imports that will take place on monthly basis. Report will provide the net figure of monthly exports & imports means gaps. Conservative exporter may take policy decision to hedge only gaps by booking purchase or sale forward covers with bank. Aggressive exporter depending upon exchange rate forecasting information may book export and import transactions separately on monthly basis.
Order sheet contains information on the basis of export orders obtained from foreign buyers. It also contain the information about the budgeted rate which is the rate applied by exporter to convert the costs into foreign currency sale’s price. Column for market forward exchange is provided to note down the forward hedging rate available on the date of application of the budgeted rate.
Information contained in order sheet will help in:-
- Taking decision to hedge the currency exposure.
- Measure the performance of the hedging action.
- Use booking, cancelling & rebooking facility to generate more cash inflows.
- Budgeted Rate & Market Forward Rate will be treated as reference rates for hedging decision.
Summary
- Exchange rates of major currencies are fluctuating with change in demand & supply position of concerned currencies
- Exchange rates has capacity to translate profit from international business transaction into loss or vice versa
- Currency Risk depends upon Nature of Currency, Amount, Exposure period and use of internal and external hedging techniques Forward Contract instrument offered by commercial banks is used by exporters/importers for currency risk management. It is easy to understand, cheap and latest RBI relaxation provide opportunities to create wealth from exchange rate movements.
- To cover currency risk, company has to develop information input system as timely decisions are essential for currency risk management and for wealth creation from exchange rate movements.
Hedging Instruments: Derivatives used for covering currency risk.
Booking Forward Contract: Exporter covering exchange risk with bank for export transaction.
Scan: Analysing daily exchange rates movements.
GAP: Difference between exports and imports transactions in a particular month.

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