Ranbaxy Laboratories, India’s largest drugmaker by sales, may be sitting on mark-to-market (MTM) losses of over Rs 2,500 crore on foreign currency
derivatives transactions entered into with various banks, according to estimates by one of its lenders in February this year.
With this lender alone, the company is running an MTM loss of Rs 600 crore on the derivatives contracts it had signed in April-May 2008. A Ranbaxy spokesperson declined comment when contacted by ET.
However, Ranbaxy is not the only company that has been hit by forex derivatives losses. The losses have cut across sectors. According to rating agency Fitch, India Inc’s estimated MTM losses on forex derivatives transactions are in the range of $4-5 billion.
Within the pharma sector, other companies such as Wockhardt, Orchid Chemicals, Cipla, Biocon and Jubilant Organosys have suffered extraordinary losses either in the form of translation losses on their foreign borrowings, hedging losses or MTM losses on foreign currency convertible bond (FCCB) issuances.
In case of Ranbaxy, sources close to the development have told ET that the drugmaker entered signed “forex options strips” contracts with the foreign bank for hedging its dollar receivables from exports for a period of eight years. A strip is like a series of options maturing on certain dates over a period of time, usually with a specified frequency. These contracts have to be settled on a monthly basis and monthly settlements with the bank started in June 2008.
When these deals were struck, the dollar/rupee exchange rate was at Rs 39.90. Ranbaxy’s forex dealers took a view that the rupee would appreciate further against the dollar and hedged its dollar receivables at an exchange rate of Rs 43.50 to the dollar at a leverage of 1:2.5. The contract stipulates that Ranbaxy delivers $1 million (out of its exports) at Rs 43.50 if the exchange rate is below Rs 43.50. Therefore, even if the dollar is trading at Rs 39, the drugmaker would collect Rs 43.50 for every dollar.
But the flip side is that if the dollar exceeds Rs 43.50, Ranbaxy delivers $2.5 million every month for a period of eight years at Rs 43.50. With the dollar quoting at Rs 50 currently, the leverage clause has been triggered, resulting in a huge MTM loss for the company.
It is not unusual for exporters to enter into options contracts to manage exchange rate risk. In a simple options contract, an exporter who expects the dollar to fall against the rupee buys an option from a bank by paying a small premium. The option allows the exporter to sell its dollar receivables at a pre-determined rupee price.
In case the dollar rises, all that the exporter loses is the premium paid for buying the option, which is set off by the gain that the exporter will make due to the dollar’s rise against the rupee, because the exporter can earn more rupees for every dollar it sells in the market.
Complications on these deals arise, when exporters start selling options to banks. In this case, Ranbaxy bought “put options”, the right to “sell” dollars to the bank at a pre-determined exchange rate, and sold “call options” to the bank, giving the bank a right to “buy” dollars from Ranbaxy at a pre-determined exchange rate.
Since the dollar has risen, contrary to what Ranbaxy expected, the bank is now exercising the “call options” at Ranbaxy’s peril, resulting in losses. Ranbaxy declared a loss on fair valuation of derivatives of Rs 784 crore in its results for the September-December quarter of 2008.