Is the red for real?

As the last set of financial results for the first quarter of fiscal 2008-09 trickled in, the ‘tick tock’ got louder, and analysts were fearing the worst—that the time bomb of foreign exchange losses of corporate India was waiting to explode.

Signs of that were amply on display in the hits a host of mega-corporations took on their bottom line in the quarter ended June 30. Profits took a beating thanks to the forex exposure either for hedging exports earning or by way of overseas debt.

As per accounting standard (AS) 11 introduced at the start of the fiscal by the Institute of Chartered Accountants of India, companies have to make provisions for their forex exposures—either gains or losses—based on exchange rate fluctuations. Till the rupee was appreciating, there was no risk as profits were rising. But now with the rupee falling, the new provision has hit profits of several companies.

If the markets are not unduly alarmed, that’s because the forex losses are more of a book entry and not actual losses. In most cases, cash flows, a key determinant of a company’s health, have not been affected. Moreover, many companies are not booking such losses into their profit and loss account, but shifting them into reserves, which is a balance sheet item.

But there may be trouble ahead. “As of now it is a book entry, but as and when the borrowings come close to the date of maturity, actual profitability will be affected,” says Ajay Parmar, Head of Research, Institutional Equity, Emkay Global Financial Services.

Adds Arun Kejriwal, Director, KRIS Research: “Such exposure is a perceivable risk, especially for companies that have foreign currency convertible bonds”. He says at the time of conversion, if the stock price of companies is below the conversion price, holders will like to redeem these bonds rather than convert them into shares. At the time of payment, the exchange rate difference will be the actual loss for the company.

But this situation has raised issues regarding accounting as well as disclosures. One option may be to transfer these losses to the balance sheet, thereby protecting the bottom line. “The objective of the accounting standard on forex exposure was transparency, but it is lost in this case,” says Kejriwal of KRIS. He says companies should also disclose their future forex exposure for the stock market to judge the risk of each company. So far AS 11 makes it mandatory to provide for mark-to-market losses or gains, but is silent on the future exposure.

—Virendra Verma