Analysis Beyond Consensus - MCA balm for MTM woes:: Edelweiss

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India Inc., to finance its aggressive growth plans, has been relying on cheaper foreign currency loans in the form of FCCBs and ECBs, which in anticipation of conversion/appreciation in INR were largely kept unhedged. During the past four years corporate India has cumulatively raised USD91bn foreign currency loans. 

However, contrary to expectations, during H1FY12, the INR depreciated steeply by 9.6% against the USD which led to a forex loss of ~INR124bn for companies in our coverage universe. During Q3FY12, the INR has further depreciated by 9.7%, which is likely to have further dented the profitability of domestic corporates.

In view of the steep depreciation of the INR, the Ministry of Corporate Affairs (MCA) has once again stepped in to rescue India Inc. Under new amendment, companies have been extended an irrevocable option to capitalise the notional MTM losses on forex loans, thus artificially boosting profitability/reserves.  

Though the amendment will cushion the reported earnings against MTM losses, we are of the view that it will lead to creation of notional assets in the balance sheet, which will be detrimental to the future ROCE, ROEs and core earnings of companies. Surprisingly, while the MTM losses are allowed to be capitalised, the cost of hedging (forward premium) will have to be amortised through P&L, which will result in lower reported profits for companies who have hedged their forex loans vis-à-vis companies who have left them unhedged.

The amended rules also provide a more lucrative option (from reported P&L perspective) to companies to fund capex through lower coupon forex loan as the exchange fluctuation (even realised gain/loss) will now be amortised through P&L over the life of asset, which is usually higher than the loan duration.