Cash Outlay Process in Pre-utilization of Forward Contract

Key Highlights

• Cash Outlay Process for Exporter
• Entry in Exporters Bank book
• Fedai Rules on Cash Outlay

Cash Outlay Process for Exporter

The moment exporter books a forward contract (sells any currency say dollars in the long term at a predetermined rate) with the bank, the bank promises to buy the underlying asset (dollars in this case) from the exporter at a predetermined date and at a predetermined rate.

Now, since the bank has agreed to buy dollars in the long run from the exporter (+), bank simultaneously enters into a buy-sell swap with some other bank to cancel the long position which it has taken with the exporter in the form of a forward contract. In this buy – sell swap, the exporter’s bank is on the sell side and some other bank buys dollars from the exporter’s bank. This leads to outflow of funds in the books of the exporter’s bank.

When the exporter takes the physical delivery of the underlying asset before maturity of the forward contract (i.e. goes for pre – utilization), exporter’s bank will have to enter into a sell (another bank will sell dollars) – buy (the exporter’s bank will buy dollars) swap with the other bank, opposite to the buysell swap that it had previously entered into. By undertaking this sell-buy swap, the exporter’s bank intends to nullify the position in its books as pre – utilization by the exporter leaves the bank with an outflow of dollars. For the purpose of arranging the swap (Sell – Buy), interest at not below the prime lending rate (which varies between 12 – 14%) of the exporter’s bank on an outlay of funds by the exporter’s bank is recovered from the exporter. Interest is charged for the number of days between the date of pre-utilization and the original maturity of the swap agreement (buy-sell). Hence, this becomes the cash outlay charge for the exporter. All the banks do not deduct these cash outlay charges. Hence, before pre – utilizing a forward contract, the exporter must confirm with his banker for such charges. The calculation of the cash outlay is done as follows:

Forward Rate (USDINR May (end) 2014): 64.00.Assuming $1Million inflow

Spot (USDINR on the date of Pre – utilization; 31st March 2014 in this case): 61.00 Cash Outlay: 64.00-61.00 = 3*10, 00,000*12%* 60/365 = Rs 59, 178 (assuming 30 days each in the month of April and May)

Position in the books of Exporter’s Bank

FEDAI rules on outlay and inflow of funds are as follows:

Interest, not below the prime lending rate of the respective Authorized Dealer (Exporter’s Bank) on outlay of funds by the Authorized Dealer (Exporter’s Bank) for the purpose of arranging the swap shall be recovered in addition to the swap cost (Forward Premium) in case of early delivery of purchase or sale contracts. The amount of funds outlaid shall be arrived at by taking the difference between the original contract rate and the rate at which the swap could be arranged.

If such a swap leads to inflow of funds, the amount shall be arrived at as above and interest shall be paid at the discretion of the banks to the customer at the appropriate rate applicable for term deposits for the period for which the funds remained with the bank.