Costly accounting

Instead of allowing firms to avoid marking foreign-exchange losses to market, regulators must increase clarity.

The National Advisory Committee on Accounting Standards or NACAS has advised allowing Indian companies to keep any losses or gains caused by exchange-rate fluctuation out of the main profit and loss accounts for the time being. This recommendation from NACAS, which is the technical advisory committee to the corporate affairs ministry, follows a period in which the rupee has suffered a sustained loss of value against the dollar, around 20 per cent since August alone. Naturally, this has hurt those Indian companies that have a preponderance of imports in their input mix, or which have dollar-denominated debt. For instance, Maruti Suzuki uses components imported from Japan, and telecommunication companies like Reliance Communications and Bharti Airtel have significant foreign loans on their books. Several power-generating companies that are dependent on foreign coal have also been hit hard. A large number of smaller companies will find it even harder to keep their margins or to roll over their foreign debt. NACAS’ recommendation will work to insulate these companies from some of the consequences of their exposure to currency risk.

At a time when India’s banking sector is under stress, and the sense is beginning to gain ground that non-performing assets (NPAs) in the financial system are not being properly accounted for, moving away from marking to market is a particularly bad idea. Those responsible for regulating accounting procedures should not have to be reminded that their job is not to make it more difficult for people to scrutinise a company’s profit and loss figures, but to make it easier. Keeping foreign exchange losses off the accounts will have major negative consequences systemically. First, it will not encourage responsible behaviour, which should include hedging of excessive currency risk. Second, it will conceal which companies are under stress, and add to the confusion about NPAs in the market, which will only heighten the fear of impending crisis. Third, it is reminiscent of some of the worst excesses of the global financial system three years ago, when brick-and-mortar companies would keep their losses from financial speculation off their balance sheets, and marking to market sometimes seemed optional. It also raises the question of regulatory confusion, as at the same time the main accounting regulator, the Institute of Chartered Accountants of India (ICAI), is suggesting that every private-sector bank branch should be audited only by Reserve Bank-approved auditors, purportedly to examine NPAs at the branch level. (The ICAI is, however, believed to be in favour of keeping marked-to-market exchange-rate losses off the main accounts, too.)

India’s investors need a uniform and clear approach to accounting requirements for companies. Regulation should strive towards making stresses or poor performance more visible. Instead, postponing the introduction of exchange-rate losses reduces clarity. Regulators should not take a call in order to protect those whom they are regulating. They should take decisions on the basis of what increases systemic strength and robustness. Marked-to-market values are the clearest indication of systemic health, and should be encouraged at the earliest.