What would happen if Best Buy enters India?

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Best Buy Co., Inc. is an American specialty  retailer of consumer electronics in the United States, accounting for 19% of the market. It also operates in Puerto Rico, Mexico, Canada and China. The company’s subsidiaries include Geek Squad, CinemaNow, Magnolia Audio Video, Pacific Sales, and, in Canada operates under both the Best Buy and Future Shop label.

Together these run more than 1,150 stores domestically and internationally. In addition, the company operates over 100 Best Buy Express Automated Retail stores or “ZoomShops”, operated by Zoom Systems, in airports and malls around the U.S. The company is headquartered in Richfield, Minnesota, United States.

On March 9, 2009, Best Buy became the largest electronics retail store (online and bricks and mortar) in the eastern United States, after smaller rival Circuit City went out of business. Fry’s Electronics remains a major competitor in the western United States, while Hhgregg remains competitive in the eastern United States. Many locations feature in-store pickup, which can be arranged through the company’s website.

As of December 28, 2008, the company operated 1,010 Best Buy Stores, 13 Magnolia Audio Video Stores (specializing in high-end electronics), 7 stand-alone Geek Squad stores, 3 Audio Visions Stores, 13 Best Buy Mobile Stores (standalone) and 17 Pacific Sales Stores (in Southern California, Arizona, and Nevada), all through its U.S. retail subsidiary. They also run 51 Best Buy and 140 Future Shop stores throughout Canada. In 2003, the company opened its first international global procurement office in Shanghai, and operates sourcing offices in Beijing and Shenzhen, primarily to cut costs and increase the speed to market by purchasing products directly from manufacturers.

As of January 2009, Best Buy operated five “branded” stores in Shanghai, one “premium” store in Beijing, as well as 151 Five Star Appliance Stores in China.

Track the currency exchange rate for the past 24 months, explain what has occurred, and name the economic variables that have most influenced these exchange rate movements.

Here we have a graph about the Indian Rupee exchange rate in the last two years. Since August 1 2011, the Indian rupee has lost roughly 20 percent of its value relative to the U.S. dollar.

While large Indian traders of bulk commodities generally hedge against exchange-rate risk, smaller traders as a rule do not, preferring to bear this risk themselves. As a result, commodities traded primarily by small and medium traders are entering an import slump. The rupee’s fall may have been arrested by a modest intervention coupled with indirect controls imposed by the Reserve Bank of India.

The Indian rupee hit a fresh all-time low against the dollar Wednesday, as risk adverse global investors wary of India’s twin deficits drowned out central bank efforts to stem the currency’s slide.

The rupee hit 54.44 against the dollar, breaching its prior low of 54.39 set Dec. 15, according to FactSet data. The slide helped send the benchmark Sensex index down 1.8 per cent Wednesday. Analysts said they expect the rupee to soften further, breaking 55 to the dollar, as Eurozone jitters dovetail with growing worries about India’s slowing growth and current account and fiscal deficits.

The Reserve Bank of India sold about $20 billion between September and March to prop up the rupee, but India’s falling foreign exchange reserves limit the bank’s ability to intervene decisively.

Analyze the exchange rate risks associated with transaction, economic, and translation exposure in the Indian market. Then, based on the tracking and your analysis, anticipate what fluctuations seem likely to occur in the next 24 months.

India’s balance of payments (BOP) depends critically on remittances, services exports (forming part of invisibles) and of course capital flows, both FII and foreign direct investment (FDI). Yet, it is essential that all market participants, including banks and other intermediaries, be provided the wherewithal to undertake forex risk management in a scientific way.

The basic principle for accessing domestic foreign exchange markets is hedging of underlying foreign exchange exposures.

To the facilities traditionally available such as booking of forward contracts, newer ones were added as the domestic forex markets evolved and acquired depth and volumes. Newer hedging instruments have included swaps and options in addition to the foreign exchange forwards.

However, to a very large extent hedging was permitted only against `crystalized’ foreign currency exposures. In layman’s language it means that only where there is an underlying forex risk arising out of a `genuine’ transaction, say an import, will the cover (hedging) be allowed.

The extension of hedging options will benefit India’s trade and has come not a day too soon. On the eve of the latest monetary policy, the exchange rate policy of the RBI was as much in focus as the interest rate policy. There has been a high degree of topicality as well.

Obviously, hedging options are particularly relevant at a time of volatile exchange rates. The RBI (Reserve Bank of India) wants the markets to be better ready to face volatility and the increased risks.

India’s exchange rate policy has ensured that the forex markets remained stable, with the rupee depreciating gradually. The situation changed drastically from March this year when the rupee started appreciating sharply against the dollar. Moving from above 44 to below 41 (to the dollar) in a span of less than two months, the rupee broke several records. There have been several well-informed analyses about why the rupee should become so strong at this juncture and whether such appreciation is in line with the exchange rate policy of the country and so on.

At a practical level, there has been increased awareness of the hedging instruments available as well as a clamor for new ones. Not only is the range of hedging tools being expanded further, but market participants will also be able to hedge on a `dynamic’ basis. Two parallel routes are being thrown open. The first are the set of liberalization measures announced in the credit policy. These include permission given to those in the trade of select metals (aluminum, copper, nickel, lead and zinc) to hedge their price risks in international commodity exchanges. Actual users of aviation turbine fuel are also being given a similar facility to hedge based on their domestic purchases.

Contracts booked by importers and exporters in excess of 75 per cent will have to be on deliverable basis and cannot be cancelled. The earlier limit was 50 per cent. Greater leeway is now being given to resident corporates to hedge their risks arising out of their overseas investments in debt and equity. Procedural changes include the freedom to cancel and retook forward contracts. Small and medium enterprises will now be permitted to book forward contracts without underlying exposures or records of imports and exports.

They are permitted to freely cancel and rebook the contracts. Resident individuals too can book forward contracts without production of underlying documents up to an annual limit of $100,000, which can be freely rebooked and cancelled.

Simultaneously, as Indian markets integrate rapidly with the rest of the world, hedging products offered at international centers such as the Chicago Mercantile Exchange should be harnessed for the benefit of Indian market participants. Cross-currency instruments using futures and options are available but as far as India is concerned there has been a serious worrying in that none of these instruments is denominated in Indian rupees.

Consider how the MNC could minimize any negative impacts of such movements. To this end, formulate at least two (2) currency-derivative strategies that the MNC can use for foreign exchange risk management. Explain how they would minimize the impact on international business operations.

The spot foreign exchange (also called spot FX or forex) market is the largest market in the world, with over one trillion $US traded every single day. One of the forex derivatives of this market is called the forex futures market. This market consists of only about one hundredth of the total size.

Speculating and Hedging are the 2 primary ways in which forex derivatives are used. ‘Hedgers’ use forex financial contracts futures to help eliminate or reduce risk by insulating themselves against any possible future price shifts. In contrast, speculators want to take risks in order to ensure a profit. There are two main techniques that can be used as forex derivatives.

Speculating is profit-driven. In the FX market, futures and spot FX do not differ too much from each other. So why would you want to identify trade opportunities in the futures market instead of the spot market? So, there will be pros and cons about dealing with forex financial contracts in the futures market.

The pros of using the futures market as a FX derivative is Lower spreads (2-3), lower transaction costs, and more leverage: often as much or more than $500 a contract. The cons of using the futures market as a type of foreign exchange derivatives is that it often requires a larger amount of capital, the fact that it is limited to the foreign exchange’s session times, and that fees may apply.

The trade opportunity strategies employed for speculating are much the same as those used in spot markets. The most widely used foreign currency derivatives strategies are based on regularly used forms of technical chart analysis since these FX markets tend to trend well. Alternately, some foreign currency derivative speculators use more intricate strategies, such as arbitrage.

When you take a closer look at hedging, you will see why there are several reasons to utilize hedging strategies in the forex futures market. A major goal is to neutralize the currency fluctuations effect on sales revenue. For instance, if a firm operating overseas wants to find out how much revenue it will get from its European stores (in US dollars); it could purchase a futures forex financial contract. The contract will be the same amount of its proposed net sales to try and eliminate the effect of currency fluctuations.

When hedging, FX traders often make a choice between futures and another of the foreign currency derivatives known as a forward. They have several differences, but the two most important differences is that forwards allows more flexibility in selecting dates and contract sizes; and that the cash that backs a forward will not be paid until the contract expiration, whereas futures-generated cash is calculated on a daily basis.

Apply a hedging technique to manage the risks of transaction, economic and translation exposures that may occur in the Indian market.

Transaction Exposure risks: In real world, a single transaction (sales and receipt) may take some period of time. For example, you sold goods to a foreign customer on 15 December 2011, and customer promised payment after two months. Now during these two months the exchange rate may fluctuate on either side and this will result in exchange gain or loss. These transactions may include import or export of goods on credit terms, borrowing or investing in foreign currency, receipt of dividend from foreign subsidiary. This type of exposure can be safeguarded by using hedging instruments.

Translation Exposure risks: When a business has several subsidiaries located in different foreign land, then it needs to consolidate its financial results of overall operations. Translation exposure affects the financials of the group when it translates its assets, liabilities and income to home currency from various currencies. The widely used mean of protecting against translation exposure is known as balance sheet hedging. In this method, assets and liabilities are matched of offset in order to reduce the net effect of translation.

For example, a company may try to reduce its foreign currency dominated assets if it fears a devaluation of foreign currency. At the same time, it may increase its liabilities by seeking loans in the local currency and slowing down payment to creditors. The firm may try to equate its foreign currency assets and liabilities then it will have no net exposure to change in exchange rates.

Economic Exposure: This type of exposure affects the value of the company. Any adverse exchange rate fluctuation will reduce the present value of all the future cash flow, thus reducing the value of the company. It is difficult to measure the dollar value effect on the value of the firm. For instance, an Indian firm is operating in other country through a subsidiary.

Assuming that the foreign country in question devalues it currency unexpectedly, this will be a bad happening for the home firm. This is because every local currency unit of profit earned would now be worthless when repatriated to India.

On the other hand, if could be a good news as the subsidiary might now find it profitable to export goods to the rest of the world. If a firm manufactures all its products in one country and that country’s exchange rate strengthens, the firm will find its export expensive to the rest of the world. Sales will be stagnant if not lowering and the cash flow and value of the firm will also deteriorate. On the other side, if a firm has decentralized production facilities around the world and bought its inputs from all over the world, it is unlikely that the currencies of all its operations would revalue at the same time.

It would therefore, find that although it was losing exports from some of its productions facilities, this would not be the case in all of them. When borrowing in more than one currency, firms must be aware of foreign exchange risk. Therefore, when a firm borrows in US dollars it must settle this liability in the same currency. If US $ then strengthens against the home currency this can make interest and principal repayments far more expensive.

However, if borrowing is spread across several currencies it is unlikely they will all move in one direction ­ upward or downward and economic exposure is reduced to considerable extent. Borrowing is foreign currency is justified if returns will then be earned in that currency to finance repayment and interest.

India’s country risk analysis

According to the economic figures, many experts believe that India’s economic growth is set to overtake China’s economic growth in a couple of years. It also said that by 2050, China, America and India are poised to be the three biggest economies. However, these reports listed these findings subject to some caveats related to country risk analysis.

Before making any investment, it is very important to discuss these caveats and analyze their implications on the general well-being in context of the Indian economy. The first important issue is getting the information about how sound is the fiscal and monetary policy.

A persistent ratio of Fiscal Deficit to GDP over 4% is viewed with concern. Countries with ratio of debt to GDP of more than 70-80% of GDP are extremely vulnerable.

India’s central bank needs to be commended for maintaining an independent monetary policy and taking effective measures to balance growth with inflation. It is the fiscal policy which is leaving the economy barefooted. Currently the central bank is raising rates in hope to rein inflation by squeezing money supply. But the inflation is proving to be sticky and not responding quickly to monetary tightening.

Part of this can be blamed to lack of tandem in monetary and fiscal policy. Government is spending more than its earnings and the spending is acting like a stimulus.

This stimulus is aiding growth and fueling inflation. Worst still the government spending is increasing in non-productive areas like subsidies and populist social programs which lack metrics for performance and delivery mechanism effectiveness measurement.

Now, let’s focus on the economic growth. The economic growth prospect of India looks very changing. One day the economy looks like it’s invincible and portrays a healthy picture for future growth. The very next day, economy starts looking vulnerable. The long growth prospects of the economy look very optimistic. But after Lehman brothers and Euro crisis, who has seen long term. Still, the policy paralysis in a difficult environment has stalled the growth momentum. The medium term growth prospects depend largely on external macros and internal proactive policy.

Also, a small current account deficit on the order of 1-3% of GDP is probably sustainable, provided that the economy is growing. The current and near term projections for current account deficit is 2.7 % of GDP. Though there may be a spike in import bill on account of depreciating Rupee, exports too may rise easing the burden on current account deficit. The current account deficit is within reasonable limits and is likely to be so in the medium and long term.

At the same time, current account deficit poses the maximum risk to India’s economy. Any substantial shift could lead to a run on the Rupee and the economy could come under serious stress. Phasing out subsidies and an efficient tax system has become indispensable.

India’s has a current account deficit so it borrows money from abroad, or in other words foreigners are net investors in the country. But the amount of money India has borrowed in within bounds on a relative basis. Besides that, it is very important to know about India’s liquidity.

By liquidity, we mean foreign exchange reserves in relation to trade flows and short term debt. An important ratio is reserves divided by short term debt. A safe level is 200% while a risky level is under 100%. The country is sitting on a reserve base which is roughly equal to short and medium term external debt. This limits the ability of RBI to intervene in the foreign exchange market to support the rupee in times of downward pressure of Rupee. Still the situation is not as comfortable and as regards the foreign exchange reserves India is just within its means.

The political situation is supportive of the required policies. In India, as in America, being in opposition means opposing every policy move of the ruling party even if it means opposing your original stand.  There is a talk of party paralysis in India thanks to inaction of UPA. But there’s a lot of contribution of opposition parties to this policy paralyses.

Without getting into this debate, this factor is the biggest contributor to country risk of India. In fact on a valuation metric, political risk will have the highest beta. The country risk premium is relatively high compared to other emerging economies. The economy is facing strong headwinds from abroad and tailwinds from within the country. Big steps need to be taken to ramp up the GDP and its growth metrics.

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About fpolom

Bachelor of Business Administration from Strayer University in Rockville, Maryland,
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