Forex Hedging Strategies For importers and exporters
In this brief write up, we provide some thoughts on hedge strategies for importers and exporters in India
Hedge strategies for importers
1. No Hedge : Some think no hedging is a good choice since forward premium is high and hedging appears to be a loss making proposition especially when rupee appreciates. However this is not a good choice as volatility leads to significant variation in cost. Also generally when INR depreciates, panic grips in and hedging is done at a higher level. Good part is that it is possible to achieve cost reduction by hedging where cost is even lower than a position of no hedge.
2. Most commonly used hedge instruments are forward contracts. Forward contracts are simple and easy to use. It is well understood and provides certainty of price. However to optimist cost, a company should have enough dynamism ( ability to utilize, cancel and rebook swiftly) if they are using forwards.
3. Plain options are a good choice and so are option structures like collars, spreads and seagulls. However it is critical that a company understands options very well before using the same. Current regulation requires a company to have 200 crs + net worth to use structures in OTC markets. Apart from OTC markets, hedging can also be done in exchanges where liquidity is available only for 1 or 2 months.
It is important to have the right monitoring mechanisms for the hedge strategies to work well.
Hedge strategies for exporters
Exporters in India extensively use forward contracts since they receive forward premium. Most of the time the forward hedge provides better rates than an open position however during times of fast depreciation, forward hedges create significant MTM losses. However our experience is if hedging is done properly then 99% of the time the company saves money.
Options like collar or range forward and plain puts are used by exporters.