When you receive money in dollars, euros, or pounds, the rupee’s value decides how much ends up in your account.
The USD-INR rate, for example, has moved between ₹73 and ₹83 per dollar over the last five years — a swing of over 13%.
A drop of just ₹1 on $10,000 can mean a difference of ₹10,000 in what you get. That’s foreign exchange risk — the chance that currency movements eat into your earnings.
In this guide, you’ll see what FX risk is, the different types of foreign exchange risk, and how to reduce its impact.
Who is this blog for?
What are Currency Fluctuations?
Before we get into risks, you need to know this. Currency fluctuation is just a term for how the value of one currency keeps changing compared to another. For example, the USD-INR rate might be ₹83 today, but three months later it could be ₹85 or ₹80. This rise and fall can impact how much you finally receive or pay when dealing with foreign currencies.
What is Foreign Exchange Risk?
This is the risk you face because of currency fluctuations. If the exchange rate changes in an unfavourable way, you could lose money.
Let’s say you’re an exporter. You sign a deal today for $10,000 worth of goods or services. But you’ll deliver it in three months. If the rupee strengthens during that time, you might get less in INR than you expected when the client pays you in dollars.
Why does Foreign Exchange Risk Exist?
The main reason is timing. When you’re an exporter or freelancer, you usually agree on a price in a foreign currency at the start of the deal. But you don’t get paid right away.
Maybe you’re shipping goods next month, or you’ll get the final payment only after delivering your project in two or three months. During this gap, the exchange rate can move up or down.
If the foreign currency loses value compared to the rupee in that time, you’ll end up getting less when you convert it. So, even if you did everything right, you could lose money just because the currency moved against you. That’s the core of foreign exchange risk.
What are the different types of foreign exchange risk?
Foreign exchange risk isn’t just one thing. It comes in a few different forms. Here are the main ones you should know about:
1) Transaction Risk
Transaction risk happens when you have an actual payable or receivable in a foreign currency — like an invoice, a contract, or an upcoming payment.
Example:
Suppose you’re an exporter in India and you sign a deal to sell $10,000 worth of goods to a US buyer. At the time of the deal, the exchange rate is $1 = ₹83, so you expect to get ₹8,30,000.
However, by the time you deliver the goods and receive payment, the rupee might have strengthened to ₹80 per dollar. So, when you convert $10,000, you now get only ₹8,00,000. That’s a loss of ₹30,000 just because the rate changed.
Note: Transaction risk directly affects your cash flow and profits. Platforms like Karbon can help you manage this risk more smoothly.
2) Translation Risk
This mostly affects businesses with foreign subsidiaries or branches. Translation risk, or accounting risk, happens when you convert the value of assets, liabilities, or profits from foreign operations back into your home currency for financial reporting.
Example:
Imagine an Indian company owns a factory in Europe that made €1 million profit this year. When they report their consolidated accounts, they have to convert that €1 million into INR.
If the euro weakens against the rupee, the reported profit in INR will be lower even if the foreign business performed well. This can impact stock prices, investor perception, and the company’s balance sheet.
Note: Translation risk doesn’t affect cash flow immediately. It is about how your accounts look on paper.
3) Economic Risk
Also called operating risk, this is the most long-term type of FX risk. It’s the risk that changes in exchange rates can affect your overall market position and future competitiveness.
Example:
Suppose you’re an Indian textile exporter selling to the US market. If the rupee keeps getting stronger against the dollar over a year, your goods become more expensive for US buyers. You may lose customers to cheaper competitors in other countries whose currencies are weaker.
On the flip side, if the rupee weakens, your goods become cheaper abroad, which can boost demand.
Note: Economic risk affects your long-term sales, pricing, and market share.
Ways to Mitigate and Manage Foreign Exchange Risk
To reduce your exposure to FX risks you have to plan ahead. Below are some practical ways you can do both:
1) Mitigate Foreign Exchange Risk
Mitigation means reducing your exposure to the risk in the first place. Here’s how:
a) Quote in your home currency
Whenever possible, negotiate with your overseas clients to pay you in your home currency (INR). This shifts the currency risk to the buyer. However, this may not always be practical if your client prefers to pay in their local currency.
b) Shorten payment terms
Try to reduce the time gap between signing a contract and receiving payment. For example, instead of 90 days credit, ask for 30 days or partial advance payments. The shorter the window, the less chance the exchange rate can swing against you.
c) Diversify markets and currencies
Don’t depend entirely on one foreign market or currency. If you sell to multiple countries, currency swings in one may be offset by gains in another. This spreads your risk across regions.
d) Price-in buffer
Many exporters add a small margin or buffer when quoting prices to cover minor currency swings. This gives you a cushion if the rate moves slightly against you.
2) Manage Foreign Exchange Risk
Management means putting tools and practices in place to handle risk that can’t be avoided. Here’s how:
a) Use forward contracts
A forward contract locks in an exchange rate today for a transaction that will happen in the future. For example, if you know you will receive $10,000 in three months, you can fix the conversion rate now. So, even if the rate drops later, you get the agreed value.
Banks and platforms like Karbon can help you set up forward contracts easily, even for small amounts.
b) Hedge with options
Currency options are slightly more advanced. They give you the right (but not the obligation) to exchange currency at a fixed rate within a set time frame. So, if the market moves in your favour, you can ignore the option and use the better rate. If it moves against you, you exercise the option.
c) Open a multi-currency account
Some payment platforms let you hold multiple currencies in your account. This means you don’t always have to convert funds immediately. You can wait for a better rate or use the foreign balance to pay vendors abroad. Karbon offers this feature and lets you hold your money for up to 60 days.
d) Monitor the market regularly
Keep an eye on exchange rate trends and set alerts. Many exporters work with FX advisors or use tools that notify them when rates reach a target. This helps you time your conversions more profitably.
e) Invoice in stages
If you have a long project, split the payment into milestones. This reduces the risk of the entire amount being affected by a single rate movement.
FAQs
Q1: Who faces foreign exchange risk?
Anyone dealing with foreign currencies — exporters, freelancers, importers, investors in global stocks.
Q2: How does Karbon help manage FX risk?
Karbon offers tools like multi-currency accounts, forward contracts, and payment holds to help you plan and convert when the rates are favourable.
Q3: Should I always hedge my foreign payments?
Not always. Hedging is useful for large amounts or longer payment terms. For small or quick payments, simple mitigation (like quoting in INR) might be enough.
Q4: Can I completely remove FX risk?
No, but you can reduce it significantly with the right mix of mitigation and management strategies.
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