Banks pitch risky hedges to Indian firms yearning for higher forex returns

By Nimesh Vora

MUMBAI (Reuters) - Banks are increasingly pitching hedging strategies to Indian companies that look appealing in the rupee's current low-turbulence spell but could leave them unprotected when they need it the most and lead to sizeable losses.

Target redemption forward (TARF) is one such product that banks, mostly foreign ones, say can help exporters get a better rate on their future dollar receivables -- even more alluring since the rupee has been in a mere 2% range since last June, with implied volatility at a one-and-a-half-decade low.

"Intuitively, TARF is highly appealing. All the more right now when you have a growing sense that the rupee is going nowhere," a senior treasury official at a large private sector bank said.

TARF, a zero-cost structure, allows exporters to sell dollars on pre-determined dates at a pre-defined rate that is significantly better than the prevailing forward rate, according to at least two different term sheets from foreign banks seen by Reuters.

"You look at it and think, "That looks like a simple way to make money.", especially for less sophisticated treasuries," the treasury official said, requesting anonymity as they are not authorised to speak to the media.

However, exporters would face significant losses if the rupee were to depreciate rapidly. And in case of rapid appreciation, a plain vanilla forwards hedge would have been better.

For example, one of the term sheets seen by Reuters said the exporter can sell dollars at 84.80 on 12 expiry dates spread over a year. At the time, the dollar/rupee spot rate was 83.25, the 1-month forward near 83.35 and 1-year forward near 84.75.

The total profit was limited to 6 rupees, at which point the option expires. The loss, however, was uncapped through the life of the contract and, in one scenario in the term sheet, could top 20 rupees if the rupee fell to near 89 over the month.

Moreover, a capped profit means the contract expires at that limit, leaving the exporter unhedged for the remaining tenure, the treasury official explained.

"Besides the extent of losses if things go wrong, the other problem with TARF is that the hedge may be taken away precisely at the time when you need it the most."

TARFs are not yet very prevalent currently and only a handful of companies have executed it.

"Right now, TARF is more a supply-side push rather than a demand-side pull," said an fx salesperson at a mid-sized domestic bank, that is currently not offering TARFs.

A few foreign banks have been actively pitching TARFs and increasingly more so recently, he said.

In another term sheet seen by Reuters, the tenure was as high as 5 years, making it even more riskier.

"During good times such structures look good but when the tide turns, there is no risk management justification for the structures," said Samir Lodha, managing director at fx risk management advisory firm QuantArt Market Solutions.

"Exotic structures can be good provided they are designed well and improve safety."

(Reporting by Nimesh Vora and Jaspreet Karla; Editing by Savio D'Souza)