Now a days Indian Startup Story is a hot news for everyone. Each day new idea, new innovation and an impressive funding. This Cygnus Atratus (Black Swan) has impacted almost all areas from Education to Health, Agriculture to Retail, from E commerce to M commerce, startup, now is everywhere and always in a new way. in a country where 10-12 years ago people tends to have a secure government job, it is a welcome trend and the trend of entrepreneurship and startups needs to appreciated as a game changer. This emerging Startup Culture especially after the Startup India Event has given tremendous psychological boost to Startups of the Country.
However, the success story of Indian Startups is not free from criticism. Experts even doubt their long term sustainability? In their zeal to get funding and valuation, Indian Startups and their funders are stuck up on Top Line and Valuation. Investor’s vested interest in this case is that their stake increases with each round of funding and promoters stake goes down. All new ventures have their own way and so the challenges for them are also different. Despite all differences most of the startups have a common driving force, which is foreign funding. Today no startup founder can imagine a good startup story without overseas findings.
Foreign Investors are also looking towards India because it is only major beacon of hope in a global meltdown scenario as Idnian has emerged as the fastest growing economy after China Slowdown. Such Investors are looking forward to expanding their business beyond the geographical boundaries by establishing new offices, incorporating subsidiaries or acquiring existing firms; reasons for such expansion are larger profit, diversified market, acquire resources and skills, to improve competitive positions, penetration into new areas and to some time as a defensive strategy.
Cross Border Funding and going global strategy has several positives and negatives including new regulatory environments, cultural differences, and political risk. We plan for mitigating these risks. But, one important risk, which is Current risks arising out of fluctuations in currency rates is often ignored particularly y startups. But do we, one very crucial factor significantly affect the likelihood of this kind of expansion strategies are Currency Movements? Answer is not very affirmative for newly ventured firms. The movements in foreign exchange rates are too crucial for a firm and specifically when it is a startup venture, and affect in various ways, can push to recalculate the obligation of debtor & creditor, re-priced the total assets and liabilities and ultimately lead to the life of company get harder.
FLOW OF EASY MONEYTheoretically the Currency movements should be driven by the economic fundamentals and progress of the economy. But the Easy money, a surplus of money flowing around the globe originated either in the form of Quantities Stimulus, Large Scale Subsidy by Governments; Emergence of Sovereign Wealth Funds (created by Governments to invest) and due to the emergence of large financial institutions and funds accessing offshore markets, have increased the currency volatility. This highly volatile money, targeting short term instruments, stock, commodity and currency market, have created some big advantages in India but if we aren’t prepare, in its worst form it can impede the business as a whole.
The problem with the flow of easy money and its effect can be seen in 1997 currency crisis of South-East Asian Countries, in sub-prime Crises of 2008 (Collapse of Global Investment Banks and other Financial Institutions, emergence of Toxic Assets and their notorious effect throughout the world) and also in the recent European double deep recession. The question is how much are we prepare for such problem, which can cause rising inflation, making loans dearer, in a commodity bubble rebalancing import and export and finally affecting production scale.
In India in the era of Liberalized foreign instruments (easy ECB norms, liberal export import policy) Indian Corporate, often carry plenty of hidden currency risk in their portfolios, either in form of ADR/GDR, FCCB, ECB, Overseas Loans or other wise and carrying huge foreign exchange liability, which may in its bad time can be responsible for the currency fluctuation.
EFFECT ON THE VALUATION OF FIRMA bid primarily depends upon the factors such as value of Capital, Assets & Liabilities and the Brand Value, the firm carries, whose value is correlated with the denomination of currency. The strength of sterling compared to the declining fortunes of the Indian Rupee means that the dollar will buy approximately 10% more than it would before the devaluation. This could make a very significant difference on large purchases. For example on 1.5, you would now retain an additional Rs. 150,000.
Earlier discussed Easy money has two effects one it affect Stock Market Trend (In India FIIs are the biggest market driver) and second the price of local currency (a big reason for the fluctuation is Foreign unstable money comes for portfolio investment); both the currency and the stock market effects may reflect errors in valuation or wealth explanations. The change in currency may affect in two ways:
1. First, in transaction happens in a foreign denominated currency and restated into foreign currency before they can be recorded. Second in translating net assets, including equity investments and liabilities “denominated” in a foreign currency. With a fluctuating currency, while offering a cross border merger/ takeover bid, it makes very difficult to communicate a clear message to the shareholders of Target Company about the real consideration and the actual price. Some sectors, have large foreign exposure such as organized retail, E-commerce, software, and outsourcing, are highly sensitive. It is a very normal phenomenon for them with the change in currency prices their shares also go up and down.Sometime a bidder is concerned about exchange rate fluctuations impacting on the value of the target chooses to make its bid conditional on a particular exchange rate, in this the deals settled in foreign exchange currency need to be specific about the circumstances triggering the exchange rate condition (e.g. what measure will be used for the relevant exchange rate and at what time will this measure be applied). Although the inclusion of such condition may have practical and compliance issues and one may always have concerns towards their role in determining real value payable/paid to the investor.
2. Two very popular strategy, solely based on prediction, leading (fasten the transaction due to the exchange rate being unfavorable) and lagging (delay the transaction with an anticipation of exchange rate being unfavorable) bidders use in a currency fluctuation environment. With this kind of strategy the investor’s interest may get affected and big chances that a group of Investor get undue advantage and other bear loss.
Now a day’s the shareholding pattern is divided among three main players Indian Retail Investor, Domestic Institutional Investor, and Foreigners includes FII, QFI and NRIs. The change in currency prices and consequently bid valuation may create a currency swapping option which ultimately makes it possible that for same transaction two investors get different consideration. Is it justified specially in context of those theories written in the Books for Corporate Governance and Investor protection?
REGULATORY CONCENRSWhether we have any system to deal cross currency acquisitions with this situation? Answer is not very assertive. It is also important to understand that India has generally been a current account deficit country. In view of the large current account deficit, the exchange rate of the rupee is susceptible to the influence of large capital movements, especially during crisis periods. The exchange rate pressure also evidences that the demand for foreign currency has increased vis-a-vis that of the Rupee in part because of the improving domestic liquidity situation.
If we talk about an investment decision made by a foreign entity in India, despite that Companies Act 2013, has now allowed the merger of an Indian Company with any Foreign Company, neither the SEBI takeover code nor ICDR has any specific provisions to deal with the bid originally denominated in foreign currency, and even the pricing norms also doesn’t cover cross currency adjustments. The Foreign Exchange Management Act, 1999 along with the Reserve bank of India regulations provides a cap of 400% of Networth for overseas expansion. This cap is in Indian Rupees and the actual value of investment, which is denominated in foreign currency, may vary and largely depend on what is the current price of Indian Rupee. The absence of clear provisions makes situation more complex. In case the consideration offered for that stake is not in the same currency as the bid consideration, how you will treat the actual value of the consideration paid due to the fluctuation in currency prices? Whether bidder and/or target entity need to make any regulatory disclosure in this regard?
The question will be more important when Target Company have a foreign stakeholder (Indian Startups need to think over it). Might due to the change in rate he may in a disadvantageous or advantageous position, can get a better/lower prices, than a domestic investor. The regulators need to come with the clearer provisions dealt with these situations.
THREAT OF INTERNATIONAL DISPUTESSince 1990, Corporate are welcoming Foreign Money and allowing outbound Investments through FPI, FDI via JV/Alliances/Technology Agreements. The Government has also promoted by Bilateral Investment Treaties (BITs) and Free Trade Agreements (FTAs). These treaties/agreements allow international dispute resolution mechanism. The number of investment disputes brought to international arbitration is continuously reaching to a new peak, amplifying the need for public debate about the efficacy of the investor-State dispute settlement (ISDS) mechanism and ways to reform. The cancellation of Telecom Licenses and consequently the compensation asked by the foreign partners, in past the dispute between an India’s leading FMCG and its foreign partners, recent Supreme Court judgment over a patent issue are some example of such kind. Actually not only the foreign partners but also the recently emerged various groups of investors are also dragging the Countries and the Corporate into legal battle by using BITs, FTAs, and agreements. The phenomenon is worldwide and India is not an exception to this.
The claims they are asking (in fact threatening) are huge enough to wipe out the benefits one can expect with the respective deals and can cause a huge outflow of foreign currency enough to unbalance the financials of the company.
SMALLER & MEDIOCRE FIRMS ARE ON RISKIER SIDE Even if a firm has no exposure towards international currency fluctuations, still it has to face risk. It may affect, positively or negatively, when competing with the firms have International Risk diversification and using product have global market or even a supply side is present from foreign source etc. Indirectly the Exchange rate fluctuations like rising interest rate change in prices, inflation and other financial effects can impact the business severally. The small and medium size companies in 2007 by failing to protect themselves from the effects of currency fluctuations lost almost £900 million.
It is also important to understand, and stated above in this article as well that India has generally been a current account deficit country. In view of the large current account deficit, the exchange rate of the rupee is susceptible to the influence of large capital movements, especially during crisis periods. Recent example where India, has been particularly affected despite their relatively promising economic fundamentals. The exchange rate pressure also evidences that the demand for foreign currency has increased vis-a-vis that of the Rupee in and this tight monetary situation can affect a smaller & mediocre firms more than a bigger one, which has better capital adjustment capacity. Mr. Entrepreneur, are you listening it?
EMERGENCE AND FAILURE OF CARRY TRADE: If one had the opportunity to borrow money at 1%, and then invest that cash and earn, say, 3%. Who wouldn’t? One would be generating essentially free money because the borrowed cash is costing less than what could earn by putting that same money to work. In the investment world, this is known as the “carry trade” – borrowing at low rates to invest at higher rates. It’s a strategy particularly prevalent among currency traders and now also being used in corporate expansion/investment world too.
In last two decades the Emerging markets like India has emerged as a favorite destination for such investors. This can be seen in high volume of Foreign Portfolio Investments, inflated share prices, sky touching stock market indexes, higher volume of trading activities, and in emergence of FII and market leaders. Easy availability of foreign money has multiplier effects on Domestic Intuitional and Individual Investors as well. The trend had benefited Indian firms in several ways, they get cheaper capital, which allows expansion more rapidly and also the facility to make international expansion as well. Indian firms went to oversees acquisitions and also for listing and issues foreign currency denominated debt, equity and quasi instruments, external borrowings with a hope of unending trends of Foreign Currency and domestic capital. The strategy has dual effects it not only increases foreign exposure and the need to an effective currency risk management system but also allows to implement operational hedging involves cross-border mergers and acquisitions (M&A), because it is possible to increase currency-denominated sales or costs by buying a foreign company. It is not very clear that whether operational hedging of currency risk exposure might drive the decision to undertake cross-border deal or not but the firms with higher exposure to target currencies, and their market values become less sensitive to fluctuations of the target currency after the takeover.
CRISIS EFFECT CREATES A CYCLE DIFFICULT TO BREAKSituation got changed after 2008 crises, which push several financial theories to be re-written, and redefined the flow of easy money, which started to search safe heavens. This time suddenly corporate touching sky on valuation becomes cheaper suddenly, have issued convertible debt instruments fell into a deep financial crunch. Some have gone for debt restructuring and some more dangerous path took debt to pay the debt. But unfortunately the easy money is no longer as easier as it was some time before. The International credit rating agencies have also downgraded risk worthiness of Indian Economy.
Results are here: Cash generated from operation goes into vein and firms are not able meet their financial obligations. This by mixing with other factors create the cycle where one needs more money to pay earlier taken money which is now available on tougher terms. The Global Investors started to look options other than the Stocks and move to safe instrument like Gold (an Anti Stocks and Anti Dollar Instrument). Retailer moved to debt instruments (in India in the last one-two years even the corporate raised money more through Bond than through Equity).
It results another cycle, sudden flow of money create Rupee weak which cause inflationary pressure and results in higher interest rate making corporate path difficult to access money . Pressure seen on lower share prices, decline in investors wealth and delayed project implementation/Expansion.
REGIONAL ZONESDifferences in valuation can affect expansion propensities through two main channels differences in wealth that occur because of exchange rate or other shocks provide a financing advantage, lowering the cost of a potential acquisition. High debt financing and large Foreign Exchange risks make Indian firms cheaper option for the Merger and can be acquired at a cheaper cost than they can be 4-5 years ago. Same time it makes Indian firms to difficult to acquire foreign firms and in some ways preventing dual way integration. But story has a lot more. In last decade so many new Investment destinations have emerged in ASEAN, Eastern Europe, Latin America, and even in Africa.
The European Double dip recession along with the weakening of Euro made European Blue chips attractive due to lower prices, the foreign investors started to move towards them. Familiar market, clearer Regulation and despite regional problem their global penetration make European Companies are in better position now.
WHAT CORPORATE CAN DOThe problem is seen only either activity specific, for short term or for a predefined period and the long term strategy to stabilize currency is left only with the Central Banks, Financial players, and with the Governments. A Close look on the Indian Corporate shows that their balance sheet is effected mostly through fluctuation in US $ than other currencies. Managing the P&L and cash flow impacts related to foreign exchange exposures can appear daunting.
The following steps, while not all-inclusive, make this task easier:
• Be cautious and carefully analyze the foreign Inward/outward investment agreement.
• Before expanding overseas or collaborating with a foreign firm define a sustained foreign Exchange paths which match with company present and upcoming objectives, all challenges and the instruments and cover
(1) The decision to search for foreign investment,
(2) An assessment of the political climate in the host country,
(3) An examination of the company’s overall strategy,
(4) cash flow analysis,
(5) The required rate of return,
(6) Economic evaluation,
(7) Selection,
(8) Risk analysis,
(9) implementation,
(10) expenditure control, and
(11) post-audit.
• A close look on possible assets creation, demand supply pattern, investment and receivables and liabilities adjusted with currency exchange rate pattern
• Assess whether the investment results in a natural offset or netting of some of the foreign currency balance sheet exposure. Re-measure the remaining net consolidated balance sheet positions due to changes in foreign exchange rates with the impacts recorded in the income statement
• Foreign-exchange rates, interest rates, and inflation are three external factors that affect Changes Currency Prices in these three factors stem from several sources, such as economic conditions, government policies, monetary systems, and political risks. Investors must have a close look on these factors.
• Monitor on an ongoing basis. Periodically review the foreign currency balance sheet positions and update changes in the anticipated foreign currency cash flows by subsidiary. Review monthly income statements and ensure foreign currency gains and losses are reasonable based on identified exposures and derivative contracts in place. If they are not, a foreign currency exposure has likely changed or not been identified, requiring further investigation
NEED FOR THE COLLECTIVE EFFORTSA foreign investment decision involves many unique environmental variables. They include (1) different tax systems, (2) foreign-exchange risk, (3) project versus parent cash flows, (4) restrictions on remittance of funds, and (5) political, financial, and business risks. The reason behind the currency fluctuation is macroeconomic and a single entity may have a little control over the same. But the effects may have substantial effects on the firm’s valuation, credit worthiness and can lead to a crisis. The responsibility to tackle this problem cannot left only with the regulator but must have to be at each level i.e. at corporate alone, through various industrial and commercial organizations and working closely with Governments. It can be possible by strengthening international alliances and growth in total fixed capital formation (i.e., private sector investment in plant and equipment plus public sector investment). In order to sustain current growth patterns, a number of supply-side issues, such as the enhancement of human resources, development of supporting industries, technological and infrastructure improvements, as well as the containment of inflation, must be addressed.
Till date it appears that India Inc and the majority of such policies will basically be for adjusting to exchange rate fluctuation vis-a-vis the U.S. dollar. With such short term majors, it will be difficult to increase the international competitiveness.
On Government front strategies should be to minimize macro-economic imbalances as well as bottle necks for growth in production and capital procurement capabilities. It is necessary to enforce a comprehensive measure which would incorporate necessary adjustment policies containing price increases and reduction of short-term current account deficits.
CONCLUSONBudgeting for an International Business Management ties come from hard thinking, careful planning, and, frequently, large outlays for research and development and must be implemented carefully.
Guest Author
Ashish is Member of ICSI & Graduate in Economics. He is associated with M/s Uniserve Knowledge Foundation (ÜKF") in his capacity as Head of Legal & Secretarial Committee.
