India ranked as the world’s sixth-largest economy in terms of gross domestic product at $2.59 trillion in 2019. Driving the economic engine of the world’s second-most populous country is a vibrant micro, small and medium enterprises (MSME) industry responsible for exporting billions of dollars worth of products.
Much like their global peers, it is vital for entrepreneurs to best manage FX for businesses to minimize losses from unfavorable currency fluctuations.
MSME Facts And Figures
India’s entrepreneurial spirit contributed to the creation of 63 million MSMEs as of 2019. The Manufacturing output of the country’s MSMEs stood at nearly 30 trillion Indian rupees in 2015 and has steadily grown since then.
The MSME sector accounted for 48.1% of the country’s total exports in 2018-2019, or $147.4 billion worth of goods. This marked an impressive jump from the prior year from MSMEs exporting a mere 7.5% of India’s total exports.
Indian enterprises exported more than 7,500 commodities to around 192 countries. The United States ranks as India’s largest export partner in 2019-2020 as it accounted for $52.4 billion of goods, representing nearly 17% of all exports.
The United Arab Emirates ranked second at $24.3 billion (9.2%), followed by China at $14.4 billion (5.5%), Hong Kong at $9.3 billion (3.53%), and Singapore at $7.6 billion (2.9%).
Needless to say, Indian entrepreneurs that sell to one or more of these markets need to manage their foreign exchange exposure. An unfavorable move in one direction could be costly, especially among those that deal with large amounts of goods but at razor-thin margins.
Case Study: U.S. Dollar And Ruppee
India’s rupee earned the unfortunate title as Asia’s worst-performing currency as of the end of June amid the COVID-19 pandemic. The rupee has fallen more than 5% in the first six months of 2020 but this type of weakness normally represents a financial tailwind to exporters.
A weakened rupee makes Indian products cheaper for their global buyer, such as an American client transacting in U.S. dollars.
An Indian enterprise could take advantage of the falling currency by lowering their prices a little bit to become even more competitive against global rivals. Instead, they can keep their prices stable and collect extra revenue by default of converting their U.S. dollars to rupees.
Given the rapid pace of global trade and an ever-changing COVID-19 situation, the rupee could experience sharp movements in either direction in such a short period of time.
Rupee On The Move
The rupee started to pick up momentum in early July, trading near the 75.00 level for the first time since late March. The rupee benefited from the U.S. dollar’s weakness as global investors were concerned with potential political uncertainty in reaction to the November U.S. presidential election.
The momentum carried over through August as the rupee gained nearly 2% in one week alone, marking its strongest weekly gain against the U.S. dollar since late 2018. Within just a few months, the rupee recovered a lot of ground and was trading at its highest level in nearly six months against the U.S. dollar.
Can anyone accurately predict what is next for the rupee’s values against the greenback or other major currencies? The answer depends on too many factors, ranging from the COVID-19 pandemic, U.S. policy towards India changes under a potential Joe Biden presidency, and even domestic Indian economic fiscal and monetary policy.
So, what happens if a customer in the United States wants to enter into a multi-year contract with an Indian enterprise in 2020 and beyond? The Indian enterprise owner needs a better grasp of foreign exchange trends and outlook to make a decision.
Fortunately, Indian enterprise wonders can eliminate a large portion of the risk associated with foreign exchange fluctuations through the use of currency forward contracts.
What Is A Currency Forward Contract?
Indian enterprises of all shapes and sizes have access through online fintech startups a suite of products and services that were once reserved for elite corporate giants. One of these services is a forward contract, an agreement established between two entities to transact with each other a currency at an agreed rate in the future.
A forward contract is typically entered for a one-year period and the vast majority of currency pairs allow for terms of up to five years. In other words, an Indian enterprise owner will know with complete certainty what exchange rate on the U.S. dollar they will receive over the coming years.
A forward contract is in essence a hedge against downside losses with the caveat of foregoing any potential gains from being on the right side of the trade.
Conclusion: Plenty Of Tools Available
The use of a forward currency contract is one of many available tools for Indian enterprise owners to mitigate their foreign exchange exposure. The need to protect against potential downside movements may be more important than ever. Tens of millions of enterprises worldwide are closing their doors.
The difference between undesirable and unpredictable foreign exchange movements could be the determining factor of remaining in business in 2021 and beyond.