The weak rupee is due to huge foreign debt

The Accounting Rules, also known as the AS-11 provision, oblige companies to make mark-to-market provisions in their profit and loss account for any change in foreign exchange debt. The biggest losers are companies that primarily serve the domestic market and opt for foreign exchange loans to finance their growth plans.

According to an ETIG analysis, companies’ profits will be marked by Mark to Market (MTM) losses. Tata Steel could report a forex loss of around Rs 344 crore, while Tata Motors could take a hit of Rs 311 crore. Tata Chemicals, which borrowed $ 475 million in foreign currency to finance its foreign acquisitions, is estimated to have incurred a foreign exchange loss of Rs 187 crore. Ranbaxy, JSW Steel and Firstsource Solutions will each lose Rs 100 crore and Rs 400 crore respectively The list of companies is not exhaustive as an estimated dozens of companies took out forex loans last year.

Fortunately, this does not only affect an accounting entry and cash flow. However, the stock market is likely to read negatively. Market participants actively track the company’s net profit and influence any adverse development assessment. The rupee had positively impacted most of the above companies until last year, but in the last quarter of September 2008 it had depreciated by more than 9%.

When the rupee is devalued, the value of foreign exchange liability in rupee terms increases and vice versa. Under the AS-11 terms, liability increases should be reflected in quarterly profit and loss statements and translate into lower corporate profits. Most firms focus on the domestic market and are therefore less likely to benefit from a weaker rupee.

The fall in the rupee will severely affect small companies, where large ones will only be moderately affected. FirstSource Solutions may report a net loss, while Tata Steel may see a 100 basis point decline in net profit margin due to foreign exchange losses. To put things bluntly, most companies will experience a 10-50% hit on their operating profit.

Companies like Reliance Communications, Reliance Industries and Bharti Airtel follow Schedule VI of the Companies Act instead of AS-11 and therefore their quarterly profit and loss statement is not affected. The operating profit of the two Reliance companies would have been around Rs 800-900 crore less if they had subscribed to the AS11 rule.