Weak rupee burdened by heavy foreign debt

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The global economic crisis has begun to take a toll on the Indian industry’s balance sheet, owing to the depreciating rupee. While a weaker rupee may bring cheer to export-oriented sectors such as IT and textiles, it has increased foreign exchange liabilities of Indian companies.

The accounting rules, called AS-11 provisions, make it mandatory for companies to make mark-to-market provisions in their profit and loss accounts for any changes in foreign currency loans. The worst hit have been those companies that primarily serve the domestic market and opt for foreign currency loans to finance their growth plans.

According to an ETIG analysis, the mark-to-market (MTM) loss will impact the profitability of companies. Tata Steel may incur a foreign exchange loss of around Rs 344 crore, while Tata Motors may suffer a loss of Rs 311 crore. Tata Chemicals, which had taken a foreign currency loan of $47.5 million for its overseas acquisitions, is estimated to have incurred a foreign exchange loss of Rs 187 crore. Ranbaxy, JSW Steel and Firstsource Solutions will lose Rs 100 crore and Rs 400 crore respectively. The list of companies is not exhaustive as an estimated dozen companies raised foreign currency debt last year.

Thankfully, this is an accounting entry only and does not affect cash flow. However, it is likely to be read negatively by the stock market. Market participants actively track companies’ net profits and any adverse growth affects valuation. Rupee had positively impacted most of the above companies till last year, but it has depreciated by over 9% in the quarter ended September 2008.

When rupee depreciates, the value of foreign exchange liability denominated in rupee terms increases and vice versa. As per the terms of AS-11, the increase in liability should be reflected in the quarterly profit and loss statement and translate into less corporate profit. Most of the companies are focusing on the domestic market and hence are unlikely to benefit from a weaker rupee.

The impact of the rupee depreciation will be on small companies, while there will be a minor impact on large companies. Firstsource Solutions may report a net loss, while Tata Steel may see a decline of 100 basis points in net profit margin on account of foreign exchange losses. To put things in perspective, most companies will experience a 10-50% drop on their operating profit.

Companies like Reliance Communication, Reliance Industries and Bharti Airtel follow Schedule-VI of the Companies Act instead of AS-11 and hence are unlikely to see an impact on their quarterly profit and loss statement. Had both the Reliance companies subscribed to AS11 norms, their operating profit would have been lower by around Rs 800-900 crore.

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