Five and a half rupees: an exporter, a forward contract and the current account
A Tiruppur knitwear exporter signed a contract in January to supply garments worth USD 2,00,000 to a buyer in the United States, with payment due on delivery in June. The rupee-dollar rate was ₹79.00 when the contract was signed and is ₹84.50 in June. His rupee production cost for the order, other than imported trims, was fixed at ₹1.40 crore; buttons, needles and labels worth USD 15,000 must be imported for the consignment and paid for at the June rate. His competitor in Bangladesh quotes in dollars and has just benefited from a weaker taka. The exporter's bank offers a June forward contract at ₹83.60 per dollar, and the exporter must choose before the shipment leaves.
1. Compute the exporter's profit at ₹79.00 and at ₹84.50, and the profit if he had booked the forward at ₹83.60. Where exactly does the gain or loss come from?
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At ₹79.00 (January rate): receipt = 2,00,000 × 79 = ₹1,58,00,000; imports = 15,000 × 79 = ₹11,85,000; net = ₹1,46,15,000; profit = 1,46,15,000 − 1,40,00,000 = ₹6,15,000.
At ₹84.50 (June spot): receipt = ₹1,69,00,000; imports = ₹12,67,500; net = ₹1,56,32,500; profit = ₹16,32,500.
With the forward at ₹83.60: receipt = 2,00,000 × 83.60 = ₹1,67,20,000; imports are still paid at spot ₹12,67,500; net = ₹1,54,52,500; profit = ₹14,52,500.
Decomposition of the ₹10,17,500 gain on spot: the export receipt gains 2,00,000 × 5.50 = ₹11,00,000, while the imported trims cost an extra 15,000 × 5.50 = ₹82,500. The import content is roughly 7.5% of the receipt and acts as a partial natural hedge.
Cost of hedging: the forward gave up ₹1,80,000 compared with spot, but it guaranteed ₹14,52,500 instead of exposing the firm to the ₹6,15,000 outcome that a rate of ₹79 would have produced. Whether that was worth it depends on the firm's margin and on whether it could survive a rate moving the other way.
2. Does the rupee's fall help the exporter, the American buyer and India's current account? Explain, using the idea of elasticity and the J-curve.
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Exporter: the foreign price is unchanged, so the gain appears entirely in rupees - his income rises 7% for the same goods. The American buyer pays the same dollars unless the exporter cuts the dollar price to win market share, which is what most garment exporters eventually do.
India's current account: export receipts are worth more in rupees and imports are dearer, which normally improves the trade balance. But the improvement is not automatic. Contracts already signed fix short-run quantities, so demand elasticities are low and the trade balance may worsen before it improves - the J-curve. Depreciation also raises the rupee cost of imported inputs, machinery and oil, and if it feeds domestic inflation the real exchange rate may barely change.
Three reasons it may not work here: (i) the export has imported content, so part of the gain is clawed back; (ii) the Bangladeshi competitor's currency has also weakened, so relative competitiveness may not have improved at all; (iii) capacity is fixed in the short run, so the exporter cannot expand volume quickly.
Terminology check: a fall in a market-determined rate is depreciation; an official cut in a parity under a fixed regime is devaluation. India's rate is market-determined, so this is depreciation.
3. Should the exporter take the forward contract? What does this episode teach a small firm about exchange-rate risk?
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The exposure: he is 'long' dollars - he will receive foreign currency and wants rupees. The risk he is hedging is therefore rupee appreciation, which would shrink his rupee receipt; here the opposite happened, so the hedge looks costly after the event. That is hindsight, not a mistake in reasoning.
Decision framework: if the order's margin is thin and the firm could not absorb a move from ₹79 to, say, ₹76 (which would cut the receipt by about ₹6,00,000 and wipe out the profit), locking a known rate is prudent. A reasonable compromise is to hedge half the exposure and leave half open, or to hedge only the portion of the receipt that covers fixed costs. The import payable of USD 15,000 should be left unhedged as a natural hedge, since it moves in the opposite direction.
Wider lessons: quote part of the order in rupees where the buyer will accept it; build a small exchange-rate buffer into the price; consider a currency option, which costs a premium but leaves upside open, unlike a forward which is a binding obligation for both sides; and record the forward rate in the costing so that the reported profit is the hedged figure, not a windfall that will vanish next year.