In 2023, Indian importers and exporters took a risk by leaving a larger portion of their foreign currency exposures unhedged, relying on the Reserve Bank of India (RBI) to maintain the rupee within a narrow range.
According to Reuters’ calculations using data from Clearing Corp of India, forward contracts purchased by importers to hedge future foreign currency payments saw a 14.5% year-on-year decline in 2023. Similarly, hedging by exporters dropped by 12.5%. Some sources suggest that the actual drop in forward hedging might be even more significant, with a senior FX salesperson at a private bank estimating it to be in the range of 20% to 25%.
The reduced reliance on forward contracts, the most commonly used derivative instruments for hedging, is attributed to the perceived stability of the Indian rupee. The RBI’s active intervention in both spot and forward markets throughout the year minimized intraday swings and overnight risks, resulting in the rupee being among the least volatile Asian currencies. The currency operated within a narrow 3.5% band throughout the year, including a mere 1% band in the December quarter.
The stability in the foreign exchange (FX) environment and a decrease in carry, which is the return on holding a higher-yielding currency compared to a lower-yielding one, contributed to clients feeling less pressure to hedge aggressively. A stable rupee and reduced carry made it less worrisome for clients to under-hedge without significant concerns about potential profit and loss.
Navigating Currency Stability: A Shift in Hedging Strategies among Indian Importers and Exporters in 2023
Looking ahead to 2024, experts like Ashutosh Tikekar, head of global markets at BNP Paribas India, express confidence that India’s substantial forex reserves provide assurance to clients about the RBI continuing its FX policy.
Despite the drop in carry, which reached a 15-year low in November due to the U.S. interest rate hike cycle, the stability of the rupee remained a key factor influencing hedging decisions. While low carry could dissuade exporters from hedging, the currency’s stability may still incentivize importers to hedge more, though not to the same extent as during more volatile market conditions. Ashutosh Tikekar, head of global markets at BNP Paribas India, highlighted the proactive role of India’s central bank in steering currency movements throughout the year.
“The stable foreign exchange (FX) environment, coupled with a reduction in carry, has provided clients with the confidence to under-hedge, alleviating concerns about potential profit and loss,” Tikekar explained.
Looking ahead to 2024, Tikekar expressed optimism, citing India’s substantial forex reserves as a key factor instilling confidence in clients regarding the RBI’s commitment to maintaining its FX policy in the near future.
Carry, defined as the return on holding a higher-yielding currency relative to a lower-yielding one, faced a significant decline in the dollar/rupee pair, reaching a 15-year low in November amid the U.S. interest rate hike cycle.
The diminished carry has discouraged exporters from actively hedging in the forward market. Conversely, for importers, the incentive to hedge increases with low carry, but this motivation diminishes when the currency is exceptionally stable, according to insights from banking professionals.
In 2023, Indian importers and exporters opted to leave a larger proportion of their foreign currency exposures unhedged. Forward contracts purchased by importers to hedge future foreign currency payments experienced a 14.5% year-on-year decline, while hedging by exporters decreased by 12.5%, based on Reuters’ calculations using data from Clearing Corp of India.
A senior FX salesperson at a private bank noted a more significant drop, estimating it to be in the range of 20% to 25%. This trend reflects a strategic shift among companies, especially larger ones, who find value in reducing their reliance on forwards in the current stable environment. Some of the hedging via forwards has been replaced by options, as disclosed by a salesperson who remained anonymous due to their company’s policy restricting media interactions.
India’s overall imports and exports recorded an 8% and 5% decline, respectively, between January and November 2023 compared to the previous year. December data has not yet been released.
