CBI to probe irregularities that caused huge losses for cos

NEW DELHI: Leading banks that entered into foreign exchange derivative contracts with Indian companies in 2007-08 will face a probe by the Central Bureau of Investigation (CBI), after the Orissa High Court asked the investigating agency to look for irregularities in such deals that drove some companies to the brink of bankruptcy.

In 2007-08, a large number of firms entered into forward contracts with 22 local and foreign banks to hedge exchange rate fluctuations. Some of those bets turned sour resulting in mark-to-market (MTM) losses to the tune of Rs 31,719 crore for these companies at the end of 2008.

Actual losses based on contracts that matured last year was Rs 755.45 crore. The remaining MTM losses on the books of Indian firms will be known when the contracts mature. Mark-to-market or fair value accounting refers to the accounting practice that records the price or value of a security, portfolio or account to reflect its current market value rather than its book value.

The total amount outstanding in respect of derivative contracts entered into by Indian firms stood at $2.4 trillion on December 31, 2008, which is more than two times India’s gross domestic product of $1.2 trillion.

Some of the companies that suffered huge losses are Wockhardt, Alps Industries, Ranbaxy Laboratories, Suzlon Energy and HCL Tech. “The matter is of national interest. If the allegations are found to be true, then CBI would be busting a large financial scam affecting the economy of the country,” the division bench of the high court said in an order dated December 24, 2009.

The court’s directive followed a writ petition filed by Cuttack-based businessman Prabanjan Patra seeking a CBI investigation into the matter. Earlier, the court had asked the agency to conduct a preliminary inquiry into the matter and file a report.

Some of the companies such as Rajshree Sugars, Nahar Industrial Enterprises and Sundaram Brake dragged banks to court last year after they discovered the enormity of losses they have made. They claimed that the banks had promised trading profits and the contracts were not made for hedging purpose. But banks maintained that the companies that bought currency derivatives were aware of the risks involved in these contracts.

“Violation of FEMA guidelines were committed by banks and exporters, who in many cases entered into derivative contracts far in excess of their genuine underlying exposure and also tried to use the hedging tools as profit-making tools,” the central bank had stated in a submission to the Orissa High Court earlier this month.

The Reserve Bank of India has laid down strict rules on the use of currency derivatives. In April 2007, the central bank issued guidelines stipulating that banks should sell derivatives only to investors who understand the nature of the risks involved.

Derivatives are financial instruments used as insurance against fluctuations in the markets. But during the market boom, many companies bought derivative contracts to boost profits. Such instruments helped them make profits, while banks benefited from the hefty charges on such transactions.