Reading the Rate Cut and the Rupee Slide
Aurora Precision, a Pune auto-components maker, earns 60% of its revenue in US dollars and buys 45% of its raw material - speciality steel and bearing assemblies - from suppliers who invoice in dollars. Its finance committee meets with five facts on the table. (a) The RBI's Monetary Policy Committee has cut the policy repo rate by 25 basis points and signalled that food inflation, though easing, remains the binding constraint on further cuts. (b) The rupee has moved from 83.20 to 84.60 against the dollar over three months. (c) Aurora has a $12 million payable due in 90 days, currently unhedged. (d) Its ₹40 crore working-capital loan is priced at "repo + 2.75%", with the spread reset annually every April. (e) Its bankers say their own cost of funds has barely moved, because term deposits were locked in at higher rates before the cut. The committee must decide, in this meeting, whether to hedge the payable and what to tell the board about interest costs.
1. The treasurer argues: "We are a net dollar earner, so the natural hedge covers the $12 million payable - leave it unhedged." Evaluate the argument.
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The observation is partly right and the conclusion does not follow. Netting dollar revenue (60% of sales) against dollar costs (45% of materials) leaves Aurora long dollars by roughly 15% of revenue, so a weaker rupee is, on balance, good for the business. That is a real natural hedge at the level of annual earnings.
But a natural hedge offsets flows over a year, not a fixed contractual payment on a known date. The $12 million falls due in 90 days regardless of how export orders perform; if receipts slip, the payable is still there, and the firm would be forced to buy dollars at whatever rate prevails. Meanwhile the rupee has already moved 1.4 points (about 1.7%) in three months, which on $12 million is roughly ₹1.68 crore of additional rupee cost if the drift continues.
The defensible position is to hedge the payable - fully or in large part - not because the firm is net short dollars, but because an unhedged known liability is a speculative position the treasury has no mandate to take.
2. How much will the 25 basis point repo cut actually save Aurora on its ₹40 crore loan, and when?
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Mechanically, 25 basis points on ₹40 crore is 0.0025 × ₹40,00,00,000 = ₹10 lakh per year - about ₹83,000 a month, or 0.25% of the principal.
Timing matters more than the figure. The loan is priced at repo + 2.75% and the spread resets every April, but the base itself moves with the repo, so the benefit typically arrives at the bank's next reset rather than on the day of the announcement. If the reset has just passed, the saving may be deferred by up to a year.
The bankers' statement in (e) explains why the full 25 basis points may not reach Aurora at all. When deposit costs are sticky - because term deposits were locked in at higher rates - banks protect their margin by widening the spread or by repricing only part of the cut. The realistic expectation is a saving of at most ₹10 lakh a year, probably less and probably delayed, which is small against a ₹40 crore exposure. The board should not be told that a rate cut has solved the working-capital cost problem.
3. What does the combination of (a), (b) and the US rate stance imply for the rupee and for the hedging decision on the $12 million?
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The RBI is easing while the US Federal Reserve is holding rates high, so the interest-rate differential between the two currencies is narrowing. A narrower differential reduces the carry that holders of rupee assets earn over dollar assets, which tends to weaken the rupee further - consistent with the move already seen from 83.20 to 84.60.
For Aurora this cuts one way. It is a net dollar earner, so continued depreciation helps translated revenue, but the $12 million payable becomes more expensive in rupees every month it stays open, and the forward market will already be pricing in some expected depreciation via forward premia. Waiting for a better spot rate is a bet against a trend that policy is currently pushing in the opposite direction.
The practical implication: hedge the payable now rather than waiting for the rupee to "come back", and treat any further depreciation as upside on the export book rather than as a reason to leave the liability naked.