Multi-National Company Entering India - Research Paper Example

? Multi-National Company Entering India Contents Introduction 3 Brief Summary of the business 4 Fluctuations In exchange rate 4 Nullifying the negative impacts of fluctuations in exchange rates 6 Two currency derivative strategies 6 Hedging techniques to manage exposure 7 A country risk analysis 9 Reference 10 Introduction When the world’s largest energy companies are taken into consideration one cannot rule out Gazprom. The company is involved in geological exploration, transportation, storage, processing and marketing of hydrocarbons as well as generation and marketing of heat and electric power. It was established in 1989. Gazprom Russian Joint Stock Company came up in 1993 under the guidance of USSR gas industry ministry. Gazprom operates in the industry of natural gas. From the demand side the factors affecting sales of the company and its profitability are weather, demographics, economic growth, fuel consumption, storage and exports. From the supply side, the factors affecting sales are pipeline capacity, storage, gas drilling, natural phenomena, technical issues and imports. The demand of natural gas has followed the cyclical pattern. It depends on time and season changes. The peak season of demand is the coldest months while demand is low in the hotter months although demand increases slightly in summer to meet the requirements of electric generators. The price of natural gas can affect demand of particularly those consumers who have the capacity to switch the fuel of their dependence. An expanding economy tends to give rise to more demand for the industrial consumers. The study of the recent activities of Gazprom will reveal whether the company is utilizing its resources. The company in collaboration with Shell is on the discussion to take joint efforts abroad with Russia as the epicenter. The company is progressing with the joint projects of EDF and Total. The company launched the informatorium website in English (Gazprom, 2012). It recently completed the pre-commissioning of Bovanenkovo. Along with DONG Energy the company is developing investment rationale for the projects of power generation in North Western Europe. Brief Summary of the business A straight forward market structure characterized the market for natural gas prior to deregulation and unbundling of pipeline. The industry has changed dramatically in the present times and exposed to choice and competition. Free market regulates the prices. Interstate pipelines offers on the components of transportation which is under the regulation of the federal. LDCs are continuing to offer bundled products although many states allow the use of distribution network but only for transportation. Producers or LDCs are the supplier to the end users. Marketers are present in the existing market structure. They serve in the process of mobilizing natural gas from producers to end users. Marketers can have their mark in sale and transport of natural gas. Fluctuations In exchange rate The following chart and the table show the fluctuations in the exchange rate: SDRs per currency unit for the period January 31, 2010 - January 30, 2011 Date Indian rupee(INR) Russian ruble(RUB) 1-Feb-10 0.01393   0.0212344   2-Mar-10 0.0142143   0.0218208   5-Apr-10 0.0147268   0.0225517   4-May-10 0.0149466   0.0227324   1-Jun-10 0.0146398   0.0219997   2-Jul-10 0.0143573   0.0214848   2-Aug-10 0.0142177   0.0217556   1-Sep-10 0.0140855   0.0214345   1-Oct-10 0.0143587   0.0210278   1-Nov-10 0.0142717   0.0206002   1-Dec-10 0.0143023   0.020779   10-Jan-11 0.0144437   0.0216247   1-Feb-11 0.0139117   0.0214905   1-Mar-11 0.0140906   0.0221084   6-Apr-11 0.0142449   0.0223142   3-May-11 0.0139446   0.0226197   1-Jun-11 0.0139248   0.0223499   1-Jul-11 0.0140143   0.0224329   1-Aug-11 0.014103   0.0225737   2-Sep-11 0.0136119   0.0214996   3-Oct-11 0.013013   0.0197337   1-Nov-11 0.0129771   0.0207838   1-Dec-11 0.0124078   0.0207745   9-Jan-12 0.0124032   0.0203137   The factors that contribute to the changes in the exchange rates are both from the supply side and the demand side. The demand side factors are the foreign demand for the goods and services i.e. the demand for the Russian exports, Demand from foreign countries for the physical assets of Russia. Physical assets include financial assets like bonds and stocks. The supply side factors include Russian demand for foreign goods as well as services, Russian demand for foreign physical assets as well as financial assets. The combined factors include the price level of Russia relative to the price level in India, the interest rate in Russia relative to the interest rate in India and the growth rate of Russia compared to the growth rate of India (Wessels, 2006, p. 290-291). The MNC produces in different parts of the world except India and so there will be cross border transactions which are correlated with the exchange rate. Therefore, the appreciation or the depreciation of the rupee is a matter of concern for the organization. If rupee depreciates they will have to pay more rupees for a certain amount of imports. The economic conditions of India are also important in this case as weak economic condition will not generate enough demand as anticipated. Therefore, estimation is important for the organization before it makes plan to enter the Indian market. The value of equities, assets or the income of the company is closely correlated with the exchange rates. Translation exposure occurs when a company denominates a certain portion of the equity and liabilities in terms of foreign currency. Nullifying the negative impacts of fluctuations in exchange rates The terms of trade of the host country can get affected by the balance of payments effects of production By the MNC. The exchange values will get reduced relative to the value of the imports if the MNC initiates to increase the production of exportable. The analysts are of the opinion that the MNC can accrue huge sum of money through the method of transfer pricing from the LDCs. The value of the imports will be inflated and the exports will get undervalued. Such a method will offset the amount they pay as taxes (Fobete, 2008, p. 1979-1980). Two currency derivative strategies Currency options are one of the derivative instruments that can be used by the MNC to minimize the risk associated foreign exchange. This derivative provides the buyer the right of not executing the specified transaction in that pair of currency. This provides the buyer the opportunity to execute settlement practice. This derivative is different from the forward and the future and provides the downside against the risk as well as benefit from favorable movements on the considered exchange rate. Since the MNC has the right to buy or sell in foreign currency it would have the opportunity to let the options expire and wait for the exchange rate to return at their favorable rate. The MNC will thereby be able to make profits that it would have not made if it had hedged through currency futures or currency forward. However the advantage is costly and generally costs more than the tools of hedging. The other advantage that is offered by the currency options is selecting the exchange rate of choice. The currency can be bought and sold at the selected exchange rate which is not in the case of forward or futures where there is presence of only one exchange rate. Another type of derivative is currency futures. The companies that wish to lock in a price at which they desire to sell the foreign currency would operate at currency futures. The forward contract can backfire if at the time of transaction, the spot rate of the foreign currency is valued less or more than the negotiated forward rate. An MNC may be inclined to use forward contracts because it is less costly to use forward contracts. A premium is required to be paid on the options contract that includes the exercise of price being equal to forward rate. The MNC has the option to use the currency options contracts in order to hedge the anticipated transactions as it enjoys the flexibility to let go the options unexercised if the transactions do not take place. Hedging techniques to manage exposure There are three types of associated risks namely transaction, translation and economic exposure. The term transaction exposure means the amount of the commitments that are present to deliver or receive outlays in foreign currency. If the commitment is in short term then the forward contract is used in offsetting the risk. The hedging procedure using forward contract is less costly and is not complicated. The hedging of the transaction exposure is carried out on the basis of overall exposure. The term translation or accounting exposure is used to mean the net book value of the assets as well as the liabilities that are denominated in foreign currency arising due to the fluctuations in exchange rates. Such kind of risks arises when there are changes in the book value of the investment of the parent organization in the subsidiary. This results in loss for the parent company. Significant losses in translation exposure may force the organization to curb the associated translation risks. The risks that arte accrued to changes in the present value of the firm or the changes in the asset and the liability because of the changes in the exchange rate is called economic exposure. The present value of the firm depends on the anticipated outcomes of the commitments that are yet to be made. Transaction exposure is less comprehensive than economic exposure. Economic exposure is dependent on the outcomes of the future while the translation exposure is dependent on the outcomes that have already occurred. A firm may also be exposed to changes in the exchange rate even if the company does not posses assets as well as liabilities that are denominated in foreign currency. Forward contract is one of the techniques to manage risks. Some of the features of the forward contract are future rate, offsetting risk, nature, speculation, and purpose. The forward contract fixes the future exchange rate of currencies. The known commitments are gets offset by forward contract. A large proportion of the operations in the forward contract are in the nature of inter-bank as well as intra-bank. There is restriction in the speculation of forward contract and useful for the traders and the investors. This technique is entered into for intervention into the market and arbitrage. The currency arbitrage operation resembles that of the spot as well as forward markets. Hedging with futures is another hedging technique. A futures contract can be used to cover the short position in foreign currency. Hedging with futures is a bit more complicated than the hedging technique with forward contracts. Currency arbitrage is another technique where the buying procedure of the currency takes place in one market while the selling of the same currency is done in another market. The company can borrow in one currency where the interest rate is lower and invest the same in another market where the interest rate is higher. Swaps constitute another hedging technique where the future cash flows are exchanged according to some formula that was pre defined. This hedging technique provides the benefits like choice, hedge, equilibrium, low cost and tax savings (Gurusamy, 2009, p. 453-461). A country risk analysis The company under consideration operates in the oil and natural gas sector. Therefore, it is necessary to explore this sector for India. The vision 2027 of the country is not a hidden secret. Currently the production of crude oil is unable to meet the total demand and the gap between demand and supply is around 31%. Therefore, the country has to rely on imports. Huge amount of foreign currency is lost as a result. The availability of domestic natural gas is around 80 cubic meters presently. The foundation of the natural gas supplies is laid with the new discoveries of gas in the East coast. The gas regulatory bill also follows the principles of creation of a competitive gas market that will attract the gas players in the country, provide a playing field for all the competitors, Creation of new establishments that will allow the suppliers of gas to intensify the exchanges in the short term between the parties and to ensure that the interests of the customers are not hampered. The usage of natural gas is emerging in the country. The industries are involving themselves in the use of natural gas. Natural gas can also be used as an alternative for cooking fuel and the government of the country is taking some efficient steps to initiate such kind of measures that will help to preserve the ever decreasing energy. Therefore, it will be wise for the company to enter into the market of the country (Sharma, 2004, p. 227-229). Reference Wessels, W. (2006). Economics. Retrieved From: http://books.google.co.in/books?id=Q5OfIb9LJQgC&pg=PA290&dq=economic+variables+affecting+the+exchange+rate+changes&hl=en&sa=X&ei=fuS5T4LUHsjsrAeh0JXiBw&ved=0CEYQ6AEwAw#v=onepage&q=economic%20variables%20affecting%20the%20exchange%20rate%20changes&f=false. Fobete, D. (2008). Multinational Corporation and the Third World Development. Retrieved From: http://books.google.co.in/books?id=nAGYUaTDNsgC&pg=PA1979&dq=how+to+minimise+negative+impacts+of+exchange+rate+by+MNC&hl=en&sa=X&ei=QRC6T9KFFYfzrQfhoZDKBw&ved=0CEcQ6AEwAg#v=onepage&q=how%20to%20minimise%20negative%20impacts%20of%20exchange%20rate%20by%20MNC&f=false. Gurusamy, (2009). Indian Financial System. Retrieved From: http://books.google.co.in/books?id=0OM0Z5TkrP4C&pg=PA456&dq=Hedging+techniques+for+indian+market&hl=en&sa=X&ei=8ym6T-jbJ4bnrAeZz4zPBw&ved=0CE4Q6AEwBA#v=onepage&q=Hedging%20techniques%20for%20indian%20market&f=false. Sharma, V. (2004). Electricity India Vision 2027. Retrieved From: http://books.google.co.in/books?id=lM_iw78QinUC&pg=PA227&dq=oil+and+natural+gas+market+in+india&hl=en&sa=X&ei=iza6T8_VIsTnrAe84t3MBw&ved=0CEkQ6AEwAA#v=onepage&q=oil%20and%20natural%20gas%20market%20in%20india&f=false. Gazprom. (2012). Gazprom launches English version of Informatorium website. Retrieved From: http://www.gazprom.com/press/news/2012/march/article131356/. Read More