Management of Currency Exchange Risk during COVID 19

5 February, 2021

Our FX Advisory desk has been inundated with queries on how best to manage FX Risk during current extremely uncertain times. Below are the points we feel one should consider while managing exposures in such unprecedented times.

COVID 19 has resulted in unprecedented disruptions in global supply chains. Businesses usually are fairly accurately able to forecast demand leaving them with one major uncertainty to worry about i.e. market risk. However, COVID 19 has introduced uncertainty on several fronts. Not only are the markets more volatile, there is less visibility about future business and there is also uncertainty about the input costs. Moreover, the uncertainty is different across different industries and geographies and even with vaccinations having begun in developed nations, it is difficult to say for sure when we would be able to get back to pre-pandemic ways of doing things. 

Several sectors may see a quick and complete recovery while several others may see a more lasting impact and for some sectors, the impact could even be permanent. While the manufacturing sector is recovering well, the service sector has been slow to recover due to mobility restrictions. Consumer psychology may change, thereby influencing consumption patterns. For example, there could be an aversion to using public modes of transport till the fear of the pandemic subsides. Many companies could embrace concepts such as Work From Home (WFH) even post the pandemic. These changes would have a huge bearing on several existing business models, but at the same time, there would also be a lot of new opportunities that would crop up. 

The key risks to manage during times like these are liquidity and leverage. The importance of having adequate liquidity cannot be stressed enough for surviving through such tumultuous times. The RBI and the government have stepped in and done their bit by extending sops to help corporates tide over a liquidity crisis. Liquidity is necessary to ensure continuity of operations and address the asset-liability gaps that open up.

Past trends of business growth may not hold for the foreseeable future. There is a possibility that the orders could get delayed/cancelled. It is important to be agile and nimble in the current scenario in order to avoid over hedging. Using options to hedge can impart a lot of flexibility in such times. Therefore, while the balance sheet exposures can be hedged through forwards, it is advisable to explore hedging through options for anticipated exposures. Paying an upfront premium to buy insurance would not be a bad idea in situations like these in order to protect the costing. A forward essentially becomes a naked position if the underlying exposure does not materialize. If the position becomes out of the money, the resulting MTM could result in LER limits getting blocked and this can be stifling because as discussed earlier, liquidity is the lifeline that can help you stay afloat in times like these. It is therefore important to draw down credit lines judiciously while keeping powder dry for when things start looking up. 

Such challenging times are also opportune times to deleverage and reconsider the viability of CAPEX projects (given the possibility of time and cost overruns, changing demand patterns etc.) that were in the pipeline to take a call on whether to put them on hold, make certain modifications or abandon them altogether.