A relatively stable rupee may be prompting corporates not to hedge their foreign currency exposures, but the Reserve Bank (RBI) is not comfortable with such a trending practice. RBI deputy governor H R Khan has warned Indian business entities against leaving their overseas borrowings unhedged, citing shrinking hedging ratios. 

"It is absolutely essential that corporates should continue to be guided by sound hedging policies and the financing banks factor the risk of unhedged exposure in their credit assessment framework," Khan said at a seminar organised by the Forex Association of India in Guragon. 

The hedge ratio, according to the central bank, for external commercial borrowings, or foreign currency convertible bonds, declined to as low as 15% in July-August 2014, compared with 24% during April-August and about 34% in 2013-14. This means, on an average, a borrower is hedging currency risk only 15% of the total exposures. 

"Large scale currency mismatches could pose serious threat to the financial stability in case exchange rate encounters sudden depreciation pressure," the deputy governor said, noting that there's anecdotal evidence of reduced propensity to hedge foreign exchange exposures arising out of a sense of complacency. Hedging bears a cost for corporates, which in turn, increases their borrowing costs. 

The average hedging cost for one-year forward currently works out to about 8.5% compared with 7.2% on an average for the full year 2013-14. It was much lower at 5.71% in the preceding year. 

Khan expressed concern as many banks expressed difficulty in assessing unhedged corporate exposures. According to RBI norms, lenders have to make a special provision for their borrowers' unhedged exposures. This could be a hindrance, particularly when the overall bank loan growth is muted at about 9.7% year-on year. 

"Given the implications of large unhedged forex exposures on the financial stability," said Khan, "it is necessary for the banking industry to act in unison to bring about awareness among the corporates about the need for adopting and implementing a well-deliberated hedging policy so that the Indian forex market is spared of regular episodes of extreme volatility." 

In the recent period, the global financial markets have been going through a phase of low volatility and the Indian markets have been no exception to this trend. (Economic Times)