Forward cover is the wrong default in India — the case for natural hedging

Every bank relationship manager in India will tell you the same thing: cover your foreign-exchange exposure with a forward, it's only prudent. Many present it as a condition of the trade-finance line. For a business with structural dollar exposure, accepting that default is one of the quietest, most consistent transfers of value from your P&L to the bank's. The rupee has depreciated against the dollar over the long run almost without exception — and a forward sells that drift to the bank at a fixed premium, then hands them the conversion spread on top. Across cycles, in the businesses I've run, natural hedging has beaten forward cover almost every time.

This is the opinionated companion to my buyer's-credit piece, where a timed forward did earn its place on a short-dated import payable. This one is about the other 90% of the time — the routine, "mandatory" forward cover that quietly costs you.

What a forward actually does to your economics

A forward rate is not a forecast. It is spot plus the forward premium, and that premium is essentially the rupee–dollar interest-rate differential — a meaningful 1.5–3% annualised. When an exporter sells dollars forward, they are pre-selling the rupee's expected depreciation to the bank at that fixed premium. The trade only pays off if the rupee depreciates by less than the premium. Given India's structural depreciation, the realised move has, more often than not, gone past it — so the hedger locks a rate the market sails through, and the difference is the bank's.

Add the spread baked into the forward rate — the IBR margin, in paise per dollar — and the forward is, by construction, a product that charges you a premium plus a spread to remove an exposure that, for an exporter in a depreciating-rupee regime, was working in your favour to begin with.

The long-run rupee reality

USD/INR has trended structurally higher for decades — driven by the inflation differential, the interest-rate differential, and a persistent current-account deficit. That isn't a prediction; it's the regime we operate in. For an exporter, that drift is a tailwind: every quarter you invoice or hold in dollars, the rupee value tends to rise. Mandatory forward cover means paying a premium to give that tailwind away — hedging against your own structural advantage.

The real question is never "hedged or unhedged." It is: who is the forward premium actually paying? Run it across a few years of your own flows. In India, in my experience, the answer has been — the bank.

Natural hedging — what actually worked

Natural hedging means arranging the business so exposures offset each other and you rarely have to convert — or lock — at all:

• Net USD inflows against USD outflows. Export receipts in dollars fund dollar import payments and buyer's-credit repayments. The exposure that nets to zero needs no forward.
• Hold an EEFC account. Keep eligible export proceeds in dollars instead of converting on receipt, and pay dollar obligations straight out of it. No conversion, no premium, no spread.
• Match tenors operationally. Line up the timing of receipts and payments so the natural offset does the work a forward would otherwise be paid to do.
• Convert deliberately, not on a bank's calendar. When you must convert a true surplus, do it on your read — benchmarked to the real interbank rate — not because a cover date arrived.

Run this way, the business carried its dollar exposure on its own balance sheet, captured the rupee's depreciation on the receivable side, and simply didn't pay the premium-plus-spread toll on flows that offset anyway. A large part of the gain came from exactly that — not from clever forwards, but from not booking the unnecessary ones.

"But the bank says forward cover is mandatory"

For the large majority of corporate exposures, hedging is the bank's risk policy, not an RBI mandate. It is negotiable. You can decline blanket mandatory cover, push back on facility conditions that assume it, and agree instead a hedging mandate that reflects your own board-approved view. I have pushed back on exactly this and run open, naturally-hedged positions — and the business performed better for it. The honest caveat: read your specific sanction terms and board risk policy. Some structured facilities or covenants genuinely require cover; know which of yours do, and which are simply the RM's default.

When a forward IS the right tool

This is not "never hedge." A forward earns its place when:

• You have a lumpy, short-dated payable you cannot naturally offset, and certainty matters more than expected value.
• You are on a thin contract margin a single adverse move would erase.
• A covenant or board mandate requires cover — comply, but negotiate the spread.
• There is genuine, dateable event risk in the window — a policy decision, an election, a conflict — where the asymmetry flips.

Even then, time it against a floor rather than locking reflexively on day one. The point isn't to abolish forwards — it's to stop making mandatory forward cover the default.

The discipline that makes this safe

Natural hedging is not "do nothing and hope." It is a posture with rules: net your exposures first, keep a defined open limit you can absorb, hold a worst-case floor on anything you leave open, and convert on an informed read against the true interbank rate. It needs a balance sheet that can carry short-term volatility and a board that understands the difference between expected value and certainty. Where those conditions hold — and for an exporting business in a structurally depreciating-rupee economy they usually do — paying a bank to remove your structural tailwind is the expensive habit, not the prudent one.