Economy

Dollar movements, Revisiting after 4 years

I wrote a blog post “Dollar Movements” nearly 4 years back in 2008, a week before the Lehman brothers collapsed and the US recession that followed. The western world still hasn’t recovered from that shock and its ripples, India with China showed resilience and solid growth but they both seem to be running out of steam now. India’s growth has now slowed  and Dollar once again gaining. In the last 12 months Indian Rupee has depreciated more than 27% to US Dollar, see the chart below. The data was from RBI Archive webpage and you can download the data from this Excel file here. Unlike last time I am rejoicing this time, read the details below.

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Coming to the story that happened four years back in early 2008. I then had a basic understanding of how Foreign Exchange contracts worked (I had explained it in the blog post in late 2008)  and to protect our margins we had taken forward contract for next 12 months, each month for thousands of dollars. 1 year was the maximum limit that RBI (Central Bank in India) allowed firms of our size to hedge their Foreign Currency receipts.

Forward Rates = spot rate +/- premium/discount

Then with the US recession that followed, we lost few of our annuity contracts there. We immediately rejigged Vishwak’s focus market to India and MEA, did some painful right sizing & in next few months managed to find the floor under our feet again. But there was very little we could do on our dollar receipts which had got reduced drastically. On top of it, Rupee depreciated to levels around 44.89 against our hedging levels of 39 to 41. This meant our bank charged us the difference multiplied by the (contract value minus dollar we received) for every month. So in the next few quarters we fought the battle from two fronts – one getting new business and growing existing engagements; second the forward contract fees which amounted to few thousand dollars impacting our cash flows dramatically.

With that painful lesson fresh in our memory, as business improved in US in recent quarters we never took any forward contracts. Because of this with the Rupee Depreciating over 27% in last 12 months, we are able to unexpectedly gain every month. I wish I had more dollars with us every month now!

Finally, this post is not to say Forward Contracts are evil or something untouchable. Just like many other financial instruments they exist for a purpose and before you take it, you better understand the risks and benefits thoroughly. For Small and Medium Businesses who need the cash every month and can’t afford to wait few months to retain as Dollars, Forward Contracts can turn out to be riskier than they appear to be.

2 Comments

  • Hi Venkat,

    Not sure what went wrong when you hedged at 39-41. Were you not getting in the dollar inflows to meet the contract, and hence bank charged you 44-39 = 5 x contract amount?

    Regards,

    Tarun

    • Tarun, you are correct. Broadly that’s what happened.

      Since I had hedged with an Indian bank for Rupee value to Dollar they lost 44-39=5, which they would have gained had I given them the promised dollars. Had $ gone other way say 35, then again I didn’t have dollars to give, then bank would have given me 39-35=4 subjected to their fine prints. even if they don’t pay me, they won’t have asked me monies in that case.