Opaqueness in forex transactions for MSMEs: How small firms can get through forex trading complexities

Due to their sizeable forex transactions, large corporates can afford to hire forex experts to negotiate with the banks, however MSMEs lack on both platforms.

Credit and Finance for MSMEs: Foreign Exchange (forex) is the lifeline for many businesses yet it remains a complex and puzzling subject for most corporates especially, MSMEs. While this industry is highly regulated and governed by the Reserve Bank of India, yet ambiguity surrounds the forex transactions – done on the OTC (Over the Counter transactions) platforms. In India, OTC forex transactions are the ones done with banks as counterparties. On average over $40 billion of forex is transacted on a daily basis over the OTC platform in India, of which MSMEs contribute to around 25 per cent. It is noteworthy to mention here that currently, MSMEs contribute around 32 per cent to India’s GDP which, as per government’s estimates, is slated to grow to 40 per cent in the next few years.

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Despite being an important contributor to the growing forex business, MSMEs often get trapped between the complexities and jargon of the forex market that often gets too technical. Spot, futures, forward, currency pair, bid price, ask price, cross pair, and various other aspects that need a hawk eye to derive advantage out of a forex transaction is lacked by them.

A foreign exchange transaction normally consists of buying and selling rate of the currency, forex transaction charges, and remittance charges. Banks however tend to share partial information with the clients. This leads to ambiguity and opaqueness in forex transactions.

One of the biggest factors in settling a forex transaction is the spot rate, the market price at which the transaction is done. Normally, real-time foreign exchange spot rates are available on live data terminals like Bloomberg, Reuters, Cogensis, etc., just like the stock prices are shown on the brokerage platforms of stock exchanges. Banks also rely on Bloomberg and Reuters for forex deal-making but most MSMEs do not have access to these live rates (real-time data terminals are quite expensive).

Banks tend to take advantage of this situation and normally quote a higher or lower forex rate (0.5% to 1.5%) than the live currency rate. They tend to build in currency fluctuations risk and combine few other charges like the bank commissions or forex transaction charges, service charges, etc. Once agreed, the bank would settle the transaction at the lowest/highest possible rate thereby making a handsome profit on each forex transaction. In the year 2020-21 Indian banks made approximately Rs 60,000 crore from overall forex transactions.

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Though clients are liable to pay these bank charges, they are not informed about the details and hence they do not know if these are genuine or if these could be reduced or negotiated. For MSMEs, these charges prove costly and are a direct hit on their bottom line. With accurate information and the right negotiation skills, these charges can be reduced substantially and the savings could be ploughed back into the business and help grow the MSME sector.

Due to their sizeable forex transactions, large corporates can afford to hire forex experts to negotiate with the banks, however MSMEs lack on both platforms. Owing to smaller transaction sizes, MSMEs neither are able to afford experts nor do they have the negotiation power against the mighty banks. This is where technology is playing a helping hand to MSMEs.

In the last year and a half, the pandemic has been brutal for MSMEs at large. The high interest costs resulting from higher debtor cycles are hurting their bottom line. The volatile currency market is also creating confusion for exporters and importers. MSMEs can negotiate themselves with the banks in case they have the access to inter-bank rates. Also, the application of cash discounts or forward premiums makes it complex for MSMEs to really understand the arithmetic around forex calculations. The absence of forex know-how and the limited capability to handle volatile forex markets is leading to consistent losses for the MSMEs.

The online forex platforms have been able to address the issue of opaqueness in forex transactions and have primarily focused on bringing transparency in the overall process. They bring the information and the massive research done by various global experts/agencies and offer it to MSMEs for taking a logical decision with respect to forex trade/transaction. MSMEs have, thus, been benefitted as they now have greater flexibility in dealing with the banks, much like the large organizations. This has resulted in the generation of substantial savings for MSMEs in the form of interest cost on forex transactions which in turn has led to increased working capital for them.

The government has been trying to give impetus to the MSMEs, and RBI from time to time has tried simplifying foreign exchange rules, and have been prompting banks to be more transparent with respect to their dealings on forex. RBI has also created platforms like Clearing Corporation of India where retail customers and MSMEs can register and do their forex transactions. However, a large part of MSMEs is yet to use such platforms and benefit from them. With more knowledge being disseminated by various players in the market, forex transactions are set to be more transparent in the future.

Anand Tandon is the Founder and CEO of Myforexeye. Views expressed are the author’s own.