The sharp depreciation in the rupee is due to structural changes, and the currency will stay there for some time. Although most export-oriented emerging markets would welcome a depreciating currency as global demand softens, India’s dependence on imports for certain sectors makes the situation undesirable. India is the only major Asian country with a current account deficit, one that has worsened since August due to falling currency, sustained high oil prices and softening exports. A flight to quality and risk aversion have resulted in capital outflows from most emerging markets. Thus, the rupee has faced pressure from current and capital accounts.
The falling rupee’s impact on the corporate sector will depend on the segment the company operates.
Oil marketing companies will be affected the most if government subsidy fails and discount from upstream companies such as such as ONGC fail to compensate them for underrecoveries. IOC is among the companies with the highest ratio of net imports to earnings before interest, taxes, depreciation and amortisation (Ebitda), which makes the company vulnerable to a declining local currency. Exposure to debt denominated in foreign exchange does not have a similar magnifying effect on debt or interest costs.
Most forex bond debt for Indian corporate issuers is not due until 2014. Eleven major issuers, including Tata Steel, Tata Motors, TCS, Tata Chemicals, Tata Power, RIL, NTPC and GAIL, have little near-term exposure to maturing forex bonds. But some will need to refinance their short-term foreign currency bank debt in 12 months. This may get challenging if rising risk aversion from Europe’s looming credit crunch extends to Asia and causes a sharp rise in spreads on forex loans. Interest costs for this short-term borrowing could jump.
Depreciating domestic currencies can create credit risk for corporate issuers through foreign-currency denominated debt and net imports. Most Indian companies denominate debt in rupee and report their financial results and balance of foreign currency debt increases in terms of the reported currency. Unless the firm must refinance the debt in the near term, the diminished value of the local currency will result in only a translation loss on reported results and in most cases does not affect Ebitda. Interest payments will increase.
The adverse impact on credit metrics intensifies for low-margin, highly leveraged firms, which typically have little room to absorb sustained currency shocks. Use of hedges on cash flows can minimise the risks, but are expensive.
The impact will be lower for regulated utilities like NTPC, where returns are guaranteed, and export-oriented companies, which benefit, respectively, from an automatic pass-through of higher costs, and from exports that have now become more competitively priced. Exports, however, depend upon demand in markets such as Europe and how India’s competing countries’ exporters price their products, as they have also seen currency depreciation. For Tata Group companies, offshore operations may accentuate or mitigate the impact of a depreciated local currency. To a moderate degree, the rupee depreciation affects those Tata Group manufacturing companies with large foreign operations.
Tata Group
For Tata Motors, the domestic base of operations will benefit little because its underlying, dollar-linked raw materials of steel now cost more. Several international carmakers use India as a production base. In the commercial vehicle segment, the weaker rupee should help Tata Motors defend its lead at home and check the growth of foreign-truck manufacturers that have a higher import component. For Tata Chemicals, we foresee the company’s main vulnerability to a depreciated rupee as coming from the higher cost of imported phosphates, where prices of the product are not controlled, unlike those of urea fertiliser.
However, Tata Chemicals and Tata Motors derive much of their Ebitda from key operations abroad. On a consolidated basis, the foreign currency debt incurred by these operations or the remnants of debt used in acquisitions will raise the level of the companies’ gross debt, but cash balances and cash earnings will improve, as measured in the rupee. Tata Steel has a lot of foreign-currency debt due to its acquisition of Tata Steel UK Holdings Ltd.
Private-sector refining companies in India limit their exposure to marketing of price-controlled fuel products and, thus, have few restrictions on their ability to pass through increased costs of imported oil, denominated in dollars. Further, as these firms sell the refined products via import-parity pricing, rupee depreciation may benefit the companies.
Reliance Industries is India’s largest exporter, so the company’s net imports relative to Ebitda are within tolerable limits. The linking of its products sold in India to international pricing will be beneficial.
Information technology services companies, deriving revenues from exports and having a rupee-denominated cost base, largely benefit from a depreciated currency. However, domestic wage inflation could offset the advantage over time. Compared with other outsourced service providers, Tata Consultancy Services relies less on exports.
Tata Power’s is largely regulated. For the regulated business, the impact of a weaker rupee on operations and margins would be largely neutral, because it can pass through forex variations on imported fuel and foreign currency debt. (As told to Rajesh Bhayani; the author is VP & senior analyst, corporate finance group, Moody’s Investors Service)