MSMEs Are Vulnerable In A Volatile Forex Market
While exporters/importers turn to ‘forward rates’ to hedge forex risk, high transaction charges and opaqueness in dealings by service providers (OTC players) hit businesses hard, directly impacting the bottom line, especially of Micro, Small, and Medium Enterprises (MSMEs).
Forex market is amongst the bright lights of the global financial markets where average transactions and trading are increasing on a month-to-month basis. In India, forex trading is still at a nascent stage but the transaction sizes have picked a rapid pace due to growing imports/exports in the country. The majority of transactions are done through the over-the-counter platform, with banks as counter-parties. Similar to the equities market, fluctuations in the global forex markets impact business transactions in India. Due to these uncertainties/fluctuations, many exporters and importers opt for ‘forward rates’ to hedge their receivables/payments.
While exporters/importers turn to ‘forward rates’ to hedge forex risk, high transaction charges and opaqueness in dealings by service providers (OTC players) hit businesses hard, directly impacting the bottom line, especially of Micro, Small, and Medium Enterprises (MSMEs). On an average, over $40 billion of forex is transacted on a daily basis on the OTC platform in India, of which MSMEs contributes to around 25%. It is noteworthy to mention here that currently MSMEs contribute around 32% to India’s GDP which, as per government’s estimates, is slated to grow to 40% in the next few years.
Armed with market intelligence, expert advice and large transaction amounts, large corporates can negotiate well with the OTC players. However, this does not hold true for MSMEs. Smaller transaction value combined with lack of timely access to live exchange rates, limited understanding of forex market operations and lack of strategic counsel by experts acts as a deterrent for MSMEs to negotiate firmly with their banks (OTC service providers).
In a forward rate transaction, an exporter/importer approaches an OTC service provider and tries to secure his receivable/payment from any currency fluctuation once the bill is due for payment at a later date. A ‘forward rate’ transaction comprises of a ‘spot rate’ - and a ‘forward premium’ of the currency pair. The spot rate is the current real-time forex buying and selling rate whereas forward premium arises due to the interest rate differential of the currency pair. However, MSMEs do not get the right spot
rate and also end up paying higher premiums (importer) or receiving lower premiums (exporter) for a given forward transaction. Usually, forward premium rates range anywhere between 0. 20 paisa to 0. 35 paisa per month per dollar depending upon the interest rate changes in India and the US. The lack of transparency on spot rates and forward premiums end up as higher transaction charges and it can cost the businesses 1-3% of the transaction value which indeed is a substantial amount for an MSME.
The impact technology has on our world is profound and to an extent immeasurable. It continues to change industries and global markets at a rapid pace every single day. Forex markets have also witnessed a renaissance change. In the last few years, tech-based forex companies have emerged and have offered enormous support to small and big companies alike. They are addressing diverse needs of the customers from providing market intelligence, access to live foreign exchange rates, expert advice to negotiating with the OTC service providers for better forex rates, etc. Technology has further enabled quick access to market information that affect forex rates, such as inflation, economic data, monetary policy, Central Bank actions, soverign debt, and political stability. Knowing these details helps businesses in evaluating risk, making well-informed and timely decisions, and selecting the right risk hedging instrument.
These tech-based forex companies are gradually providing a level playing field to organizations especially to MSMEs. More so, they are bringing transparency and eliminating opaqueness in the forex transactions which in turn bring huge savings for businesses and adds to the bottom line.
While the government has been trying to give impetus to the MSME and RBI from time to time has tried simplifying foreign exchange rules, a lot is still to be done to further help reduce opacity around the forex transactions especially by OTC players.