The Two Sides Of Opportunity

In recent weeks, Mahindra & Mahindra has become a major player in the money market. The company's corporate treasury has been actively investing in treasury

bills of short duration. Great Eastern Shipping is another company that has increased its focus on money market instruments. L & T too has been closely watching this market.

Companies with full-fledged treasury operations have suddenly found increased business opportunities in the post credit policy scenario. The slack season credit policy announced by the Reserve Bank of India (RBI) in April 1997 and the developments since then have significantly changed the market equations. And thrown up new openings for savvy treasury heads. Even as companies like Reliance, L&T, Bharat Petroleum, Essar, Hindustan Lever and Mahindra & Mahindra are gearing up to make the best of the opportunity, some other cash rich companies are said to be planning to set up treasury departments within their fold to exploit the new potential.

 

At the same time, corporate treasurers also recognise that the opportunities come with risks attached. Following the expected development of the term money market, money market and banking circles foresee more volatility in interest rates as well as in the value of the rupee against other foreign currencies. Companies have to guard against these risk factors. "In the new dispensation, asset price risk will be substantial," cautions Girija Pande, general manager, ANZ Grindlays Bank.

The budget for 1997-98 and the credit policy following it have given considerable freedom to companies to manage their financial affairs. What are these measures that will affect the fortunes of corporate treasuries?

New avenues

For one, the credit policy has done away with the cash reserve ratio (CRR) as also the statutory liquidity ratio on inter bank liabilities -- a long pending demand of market players. This measure is expected to increase liquidity in the banking system, and bring down the lending rates. More funds will now be available to companies at a lower cost.

Soon after the credit policy, interest rates all round have begun to decline. Lending rates, for example, dropped from 20 per cent and more to 16 per cent. Banks and financial institutions (FIs) have initiated measures based on which they will soon encroach upon each other's traditional territories. While FIs have started looking out for working capital avenues, banks are seeking to get into the term loan market. "This is good for companies as they now have more avenues to source money from," points out Prem Bajaj, head of corporate relations at Essar group.

Additionally, treasury bills of varying maturities are expected to be introduced soon, facilitating better cash management by companies. Until now, few companies have been looking at the government paper market for short term investment because the extent of liquidity has been inadequate from their point of view and the returns have so far been lower than they would like. However, with a general decline in interest rates and more maturities hitting the market, the situation could change soon, says the treasury head of a cash-rich shipping company.

In addition, the importance of the loan system in credit delivery has been enhanced with effect from this financial year. The minimum maturity of commercial paper has been reduced from three months to 30 days. In forex, the need to produce documentary evidence for the underlying transaction has been done away with. This is expected to facilitate longer term forward covers for the companies, unlike in the case of a maximum of six months as of now. For companies willing to convert their rupee liability into another currency, the RBI has allowed them the swap facility without prior approval.

Apparently, more instruments than before are now available to companies on the liabilities side. On the assets side too, they have more options. Repos have now been allowed in all securities, which should provide incentives for companies to look at this market more closely. A beginning has already been made on the money market mutual fund front, with Unit Trust of India and Industrial Development Bank of India announcing their schemes. All these should offer more room to companies to improve their liquidity management. "We are closely looking at the options available for raising resources as also their deployment," says L Krishna Kumar, chief treasurer at Larsen and Toubro (L&T). In fact, L&T is believed to be working on a few new schemes for this purpose.

An important feature of the credit policy was that the rigours of maximum permissible bank finance (MPBF) have been given the go by: banks and companies now have the freedom to follow whatever concept of bank finance they want. "Money now should be available as and when production requires it, not when banks want to give it," says Bajaj.

The flexibility in cash management that the new dispensation permits will be useful to the corporate sector in many ways. If managed well, it will help them reduce the mismatch between cash inflows and outflows. According to Bajaj of Essar, repayment schedules earlier were not matched with cash inflows. "We now have more options for matching," he says.

And with the reduction in cash reserves stipulations for inter bank liabilities, the money and forex markets are integrated more closely than ever before. A reference rate is likely to emerge following the CRR removal as also the introduction of an active bank rate for this purpose. As a result of these developments, premia rates on forward forex deals are likely to get aligned with the reference rates. This should make predicting the interest rates that much easier.

The flip side

But there are challenges, too. For example, with the reduction of the cash credit facility, companies will have to be more careful

with their cash management. "With the cash credit facility restricted, liquidity management for corporate treasuries has become more important," says Krishna Kumar.

However, what worries some players is the international credit ratings that India has these days. They feel that with better ratings, many more opportunities should open up for Indian companies to raise money abroad. Nevertheless, some leading Indian companies, notably Reliance, have set the trend by raising money for 50 and even 100 years. These developments open up the gates for long-term money for companies, which should help them in their projects. "This kind of tenure will be ideal for infrastructure projects," says Bajaj.

Even as savvy companies are closely watching the emerging market trends, their risk perception too is undergoing a change. For instance, the erstwhile consortium approach is expected to fade away giving place to numerous other alternatives. However, from the corporate treasury point of view, this will pose a challenge as companies will have to tackle uncommitted facilities now on. This will be a drastically different situation compared with the consortium approach, where funds were committed upfront. "This will pose a challenge for liquidity management, as hardly any company will be ready to go for instruments like commercial paper for their entire requirement," points out Krishna Kumar.

Similarly, the new dispensation involves forex versus rupee loan risk, as currencies keep on gyrating. The newly earned currency swap freedom has been welcomed by the players and there are yet early signs of the market developing in this area. As some observers point out, the market is expected to witness a variety of floating rate instruments. And as options multiply, companies will be required to make policy-oriented decisions regarding the extent of risk they would like to take.

But there could be still a hiatus between the opportunity and the treasury's ability to encash it. "The new opportunities would require specialised skills at the treasury level," points out

Krishna Kumar. Having undergone a three-year period of tight liquidity conditions, the market has thus begun to improve throwing up business opportunities for companies. But how long will the situation last?

The essential factor that will determine this is the capital flows into the country. While some players believe that economic fundamentals have become independent of political uncertainty, others outline a framework of eight to ten months for the current phase of liquidity. They expect interest rates to go up after that, thanks largely to heavy government borrowings from the market, and the consequent rise in inflation. A significant rise in interest rates will be sufficient to upset the game, they feel.

Caution: casinos ahead

As more companies move towards setting up treasuries, experts have a word of advice for them. Some companies use treasuries for profits while others use them for hedging their exposures. Money is traded like commodities in this market, sometimes with large exposures without adequate limits or prudential norms. And this is where unrecognised risk creeps in, says Girija Pande. To avoid a major debacle, companies must put in adequate controls, limits, delegation and appropriate accounting policies. "In the absence of such safeguards, there would be a casino like situation," he says.

Another area of risk comes from subsidiary companies floated abroad by Indian companies. Typically, there are communication gaps, with the parent body not having full information on the activities of their siblings across the seas. These subsidiaries often trade in money without any restrictions. And expose the whole group to high risk. What happened at ITC Global is a typical example of this, says a senior manager of a cash rich company.

As Krishna Kumar succinctly puts it, more options are now available on both the assets and liabilities side. Optimising the choice, thus, becomes important for the corporate treasury.

Companies will have to take vital decisions at the policy level before they can fully utilise the opportunity.

The corporate treasury function

Treasury management as a financial discipline takes a broad view of a company's financial position. Its main objective is, first, to have cash when and where it is needed and second to put cash to

the best possible use. The exercise involves the short- and long-term forecasting of cash flows. A treasury management system should try to meet obligations with funds that were earning interest upto the last moment before disbursement. It also means having funds ready to gain every available advantage by prompt payments. The underlying premise is that of time value of money which says that a rupee received and put to use today is worth more than it is tomorrow. For treasury heads, it means a constant emphasis on acceleration of inflows, regulation of outflows and diversion of spare funds into profitable investments.

Risk is a critical component in developing an optimum treasury management system. The recent events at Barring's, Sumitomo etc. only reinforce the need for effective control mechanism within a treasury system. The timeliness and accuracy of information is of great importance. The treasury head needs to understand and operate within the prescribed systems.

Treasury operations must be viewed in terms of financial risks, flexibility and opportunity costs. Financial risk measures the ability of the firm to meet future debt service obligations. Flexibility refers to its ability to alter a course of action to

meet unspecified financial requirements. And opportunity cost is the measurement of the maximum profit that could have been earned had funds been put to alternate uses.