Forex derivatives losses may be India's subprime

13 Apr, 2008, 0300 hrs IST,Dheeraj Tiwari, TNN

NEW DELHI: Last year, the word ‘subprime’ found its way into almost all dictionaries and was even awarded the ‘word of the year’ title. But that was last season. This time it’s ‘Exotic’, which has soured the flavour. At least this stands true for banks and corporates which tried this recipe for garnishing their balance sheets.

As more and more companies come out in the open and knock the legal doors seeking an intervention, the forex derivatives losses may well turn out to be the subprime crisis for India Inc. And once again, the banks have found themselves in the vortex of this financial crisis.

According to a Credit Suisse report, the size of the potential market-to-market (M2M) losses at corporates is placed anywhere around Rs 120- 200-bn. The report also states that the total hit for Indian private banks is about $328-mn or 1.8% of book value (BV). This doesn’t come as a surprise, when already the Finance Minister, P.Chidambaram accepted that the exposure of banks operating in India — including foreign banks — to derivatives grew 291% in two-years to reach Rs 127.86 trillion by end of 2007.

Analysts may agree that the erratic currency movements may have triggered this blood bath but there is no consensus on — whether it is the corporate house who went wrong or was it the banks’ zealous approach, which made them enter into complicated derivative contracts.

Some companies such as Rajshree Sugars, Garg Acrylite, Nahar Industrial Enterprises, Sabare International and Sundaram Multi Pap have already filed suits against their banks. And some of the leading banks such as ICICI Bank (Four cases), Kotak Mahindra and Axis Bank (two cases each)are already resorting to the legal means. Already, Rajshree secured a ‘status quo’ order against Axis Bank from the Madras High Court. But neither these are exceptional cases nor all companies and banks are looking forward to the legal course.

“This is so because in some cases these companies have a far more intrinsic relationship with their banks, which goes beyond buying or selling derivative products. Why hasn’t Sundaram filed a case against SBI?,” asks a leading banker.
But if analysts are to be believed this is just the tip of the iceberg. “Not all companies have come out with their losses.

It’s only the small medium enterprises who’ve moved to courts. For them it’s a do or die situation. If you scratch the surface, you’ll find that all companies including those listed in BSE-30 have suffered,” says a investment banker. Berjis Desai, managing partner, J Sagar Associates, the legal firm which is advising some of the affected corporates believes that the menace though widespread has found some bad losers who just want to join the bandwagon.

“Out of the 12-15 suits that have been filed, 3-4 don’t stand any grounds. The reality is that only those companies who can prove that there was no underlying exposure and still their banks sold these exotic derivatives product to them will eventually emerge victorious,” he says.

But banks feel that they’ve an iron-cast defence and most of these cases will fall flat when contested. “These options are not something new. They have been existing for a long time. In fact trading in these options had a become a popular tool for profit management. We’ve received requests, where the clients actually knew what product they wanted. They just wanted us to quote the price,” says a senior official of leading private bank.

According to the Credit Suisse report, Indian banks have a 25-30% market share among large and 60-65% among mid size corporates in complex derivatives. “You’ve to understand that they are not new products. They’ve been in use for the last 8 years.

And once the strong players (large corporates) knew that it’s turning turtle they moved out. They have greater risk management tools. But it wasn’t easy for mid size corporates,” says Jamal Mecklai, CEO, Mecklai Financial.

Another twist to this fairy tale, which went horribly wrong is that since RBI doesn’t permit significant open positions on forex, many Indian banks did the deals and in turn entered into back to back deals with foreign banks. “It was so because Indian banks didn’t have those exotic products, they bought it from foreign banks and sold them to corporates. There is nothing wrong with these products. It’s just like a cricket bat in your hand, you need to know how to use it,” says Mecklai.

But this vicious cycle is as complex as the product itself. “It may have happened with a few banks but the hard fact is that foreign banks facilitate the external commercial borrowings (ECBs) at a very negligible cost. In turn companies deal with them when it comes to handling their forex business or derivative products,” says an official of a leading Indian bank.

Though the situation may worsen from here on, some analysts believe that the concerns regarding potential forex derivative-related loses are overdone. The Credit Suisse report also states that it is unlikely that losses for the bulk of the corporates individually will exceed a level that would significantly affect their ability to repay or to borrow (as corporate sector leverage is still extremely low.)

The announcement by the Institute of Chartered Accountants (ICAI), directing companies to follow new accounting norms that would require them to disclose and provide for their derivatives losses with immediate effect has also added to the confusion.

“The institute (ICAI) announcement is very clear requiring corporates to tell the mark to market losses and disclose them separately. However, there are conflicting reports whether there should be a provision or disclosure. If the institute view is that disclosure only will suffice, it should clarify immediately,” says Viren Mehta, director, Ernst &Young, India.

Doubts are raised even on the taxation part. Says, Amarjeet Singh, partner, KPMG : “It’s not clear whether the companies can claim deduction on unrealised losses or not, besides being tax deducted on gains because some of the deals haven’t been executed yet.”

For now it appears that the much relied upon forex derivatives may have turned into the proverbial Titanic for corporates and banks alike, as for survivors they’ll have an exotic tale to narrate!

VIA: Economic Times