Translation risk - who to blame - how not to blame
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Jay Shah
Dec 15, 2011, 9:04:52 PM12/15/11
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Translation risk - who to blame - how not to blame
The Q2 results of leading corporates have arrived by now with Translation numbers all in red. who to blame - of course everybody has blamed the Rupee depreciation. But the corporates too have to share the blame. Not because they did not anticipate the pace & extent of move- Even the brilliant minds make guesstimates only after 50% move is done !! . Very few learned from 2008.
Corporates are confused between chasing accounting goals and real risks. The fear of an lost opportunity due to lock-in from a hedge is difficult to sink-in . However the translation loss is oft treated as a notional with complete confidence that the currency will take care in next quarter, so as to write back. Problem comes when Currency shifts its trading zone altogether and refuses to budge . The translation now starts getting converted into a Real Cash loss
The forward premiums in Q1 were definitely higher 5-6% p.a -- a hedging cost. Most of those who did not cover, did so with anticipated Rupee value at time of maturity of the Hedge with an argument that its a sunk cost. Thus the known sunk cost was traded with an unknown translation risk which eventually becomes an even higher sunk cost.
For almost all , the cost of rupee borrowing was 10%+ and the premise of dollar borrowing is clear - i.e to reduce the wt avg. cost of debt . The Fx. element however gets ignored. This happens because the business units do not work in tandem. The fund raising unit achieves its target by resorting to dollar borrowing and acheiving the target wt avg cost of funds. The accounting unit aims for further cost reduction through currency movement. Ideal would be an end-to-end fund raising cum cost saving exercise on fully hedged basis.
There are very few occasions which the market presents , wherein one can target translation as well as real risk. For e.g 5 year MIFOR in 2008 and 2011(5-6%) would render a fully hedged cost of $ funds to 8-9% INR (against 11-12% INR funds). One had the chance to hedge accounting as well as market risk with a single swap. What comes in the way is greed to further optimise by playing with the currency - hoping it would appreciate further from initial conversion rate .
The Q2 results of leading corporates have arrived by now with Translation numbers all in red. who to blame - of course everybody has blamed the Rupee depreciation. But the corporates too have to share the blame. Not because they did not anticipate the pace & extent of move- Even the brilliant minds make guesstimates only after 50% move is done !! . Very few learned from 2008.
Corporates are confused between chasing accounting goals and real risks. The fear of an lost opportunity due to lock-in from a hedge is difficult to sink-in . However the translation loss is oft treated as a notional with complete confidence that the currency will take care in next quarter, so as to write back. Problem comes when Currency shifts its trading zone altogether and refuses to budge . The translation now starts getting converted into a Real Cash loss
The forward premiums in Q1 were definitely higher 5-6% p.a -- a hedging cost. Most of those who did not cover, did so with anticipated Rupee value at time of maturity of the Hedge with an argument that its a sunk cost. Thus the known sunk cost was traded with an unknown translation risk which eventually becomes an even higher sunk cost.
For almost all , the cost of rupee borrowing was 10%+ and the premise of dollar borrowing is clear - i.e to reduce the wt avg. cost of debt . The Fx. element however gets ignored. This happens because the business units do not work in tandem. The fund raising unit achieves its target by resorting to dollar borrowing and acheiving the target wt avg cost of funds. The accounting unit aims for further cost reduction through currency movement. Ideal would be an end-to-end fund raising cum cost saving exercise on fully hedged basis.
There are very few occasions which the market presents , wherein one can target translation as well as real risk. For e.g 5 year MIFOR in 2008 and 2011(5-6%) would render a fully hedged cost of $ funds to 8-9% INR (against 11-12% INR funds). One had the chance to hedge accounting as well as market risk with a single swap. What comes in the way is greed to further optimise by playing with the currency - hoping it would appreciate further from initial conversion rate .
Indian firms have yet another year to spread fx. fluctuation impact by recognising such differences over the period of the underlying asset/liability. IFRS requires such differences to be immediately charged to P&L A/c . As some radical opinions float in the market maybe this maybe the decade of 50`s to 60`s for Rupee. But , nevertheless, there would be occassions wherein one can latch on by having clarity of tackling market risk rather than accounting risk and seizing those rare moments like in 2008 and 2011 where a single instrument tackles both issues.
--Prateesh Sane (Certified treasury manager (CTM))
Author of this article is a full-time working Risk Manager. Views expressed are strictly his own.
Do mail back for views / opinions / doubts / consulting / advisory / job offers.
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Best Regards,
Jay Shah, FRM
Expect the unexpected!!!
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