There is no denying that the big economic picture is still pretty bleak. All forecasts for the coming months (from IMF, World Bank and the UN) predict downward GDP growth trends. The only piece of good news is that India Inc. has not fared that badly. Government statistics say the country’s GDP grew at 5.3% during the quarter ending December 2008. Amidst negative global GDP growth predictions, the IMF has projected India's growth at 6.25 % in 2008-09 and at 5.25 % in 2009-10.

But let us not overlook the severity of the slowdown here. The IMF’s report on the global financial crisis indicated that the current global growth forecasts are the lowest in the last 60 years. The advanced countries are the worst hit. The US is witnessing a major fall in its global trade volumes. Unemployment numbers are at their highest since 1967.

Developing countries are comparatively better off, having secured some immunity against the financial crisis - a result of strict banking sector regulations and a growing domestic market.

India is facing the trickle-down effect of the slump. Annual industrial growth dropped to 3.2% between April and December, 2008-09, against 9% a year ago. While growth in the core infrastructure sectors fell by 1.1%, the broad money growth fell by 5.0%. The fiscal deficit during the April-December season, 2008-09, also shot up by 181.3% even as the revenue deficit got higher by 343.3%, as compared to the corresponding period last year.

According to an Economic Times survey of 1,450 listed companies, the profit growth of India Inc. dropped to 5.7% in the second quarter of 2008-09 against 25.8% (YoY) - 20% of companies reported losses in the second quarter of 2008-09 against 14% a year ago.

The situation is bound to improve though with the US government bailing out its banks and launching massive restructuring and recapitalisation programmes. Governments across the world are also trying to use fiscal and monetary measures to strengthen their economies.

While it is important to understand the changing trends, comparisons with the past are immaterial. The approach to deal with the current business environment must be reset and a new path must be sketched out.

Some of the challenges that come with the slowdown are:

• Credit Crunch
• Worsening Fiscal Situation
• Slowdown in Investment, Employment and Income
• Continued Slide in Demand
• Rise in Volatility in Commodities Prices
• Rise in Volatility of Exchange Rates

Exchange rates have never been as volatile as they are in the current times, where they fluctuate on a daily basis. To cope with the challenges of the new economy, companies should try and have a robust foreign exchange management system.

Surprisingly, however, companies do not practice hedging against currency risks. Export or import houses usually leave their funds open, subjecting their margins to constant risk. This means, a small oversight could lead to disastrous repercussions on the financial health of the company.

In the current market scenario, hedging against foreign exchange risk is a logical, practical and rational approach.

Here are a few reasons why derivatives should be used for hedging against volatility:

• To protect profits against market volatility
• To reduce volatility in revenues and costs by minimising uncertainty
• For better inventory management
• Helps strategic decision-making as a result of better control over prices
• Increases competitive pricing of finished products
• Improves borrowing capacity

There are, basically, two types of derivatives - forward and future contracts. While forward contracts are typically traded through banks, future contracts, a relatively nascent form of derivatives, are traded through exchanges. Exchange trading has some distinct advantages.

• Price Transparency – While rates vary from bank to bank, the same exchange rate is applicable to all companies. An exchange does not require an underlying asset. The trading is completely based on the export and import figures.

• Ease of entry and exit – Trading with a bank requires a formal procedure of “proof of contract”, declaring remittance etc. However, an exchange requires no documentation. A client simply requires access to his trading screen to buy or sell. It ensures ease of entry and exit into the contract depending on one’s level of exposure.

• Zero counter-party risk – In an exchange, the contracts and all positions taken are guaranteed by the exchange, unlike a bank where the trader takes the risk on the bank.

• Low impact cost – The transparency of mark-to-market is much higher in an exchange, as compared to a bank. If the trader is out of money at an exchange, he can cancel his position, and take another. At any point, you can square your position, pay in or pay out, on a daily basis. This saves the trader from volatility shocks. A bank, on the other hand, provides the mark-to-market rate only on a periodic basis. Taking a roll over or squaring off a position through a bank is comparatively difficult.

• Price benefits – The price mechanism of an exchange is more sensitive and capable of dealing with volatility. A bank still depends on the older system of floor trading. Through the exchange platform, however, the functioning price mechanism makes a “stop loss” possible.

In a risk-filled environment as this, hedging is no doubt a safe and feasible option for shielding a company’s foreign exchange position. It allows organisations to mitigate non-productive risks and focus on their core competencies. Put simply, hedging allows a business owner to eliminate the uncertainties attached to any foreign-currency transaction. While risk is a fact of any business life, it is also a good idea to have a system in place to control and mitigate its impact.

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