In the past three months, foreigners have pumped close to $700 million into Indian equity. Not bad at all given the twin horrors of war and elections. It's even more optimistic since historic dollar-denominated returns have been pathetic.
In the last 18 months, the rupee has slid 8.6 per cent per annum versus the dollar. In January 1994, the rupee was trading at Rs 31.4 to the dollar whereas it is at Rs 43.23 now. That is an annualised depreciation of around six per cent. The Dollex was at 230 points in January 1994 and has dropped to 174 points which is about a six-per cent loss per year.
This means that few foreigners could have made any money. Ironically, the biggest bull market occurred simultaneously on Wall Street. While the currency factor is ignored by most Indians, it is a primary consideration for the FIIs. With increasing freedom for Indian corporates to raise money abroad, it is bound to become a major parameter soon. Once full convertibility comes, debt will be benchmarked to international rates and so will equity returns.
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Full convertibility may still be distant. But every indication is that the rupee will continue a "managed" slide. This will correct for a negative trade bala-nce and aid exporters to remain competitive. The Brazilians had a mandated slide of 0.6 per cent per month for many years. Less formally, RBI is heading the same way. Since mid-1997, the rupee has been under severe pressure as east Asia saw steep falls, making Indian exports costly.
For the Indian investor, protection lies in targeting companies with substantial export earnings. This is why pharma and software stocks are over-priced. Hotels and shipping are two export-oriented industries under-priced due to recession and obviously worth investigating for the value investor.
Just how does the normal investor keep a perspective on currency moves? The RBI uses complicated trade-weighted currency baskets to calculate the Real Effective Exchange Rate (REER) which is compared to the actual spot and forwards. The investor can make a useful calculation to establish likely trends.
The calculation goes like this. You have Rs 100 which will yield Rs 111 on a one-year fixed deposit at 11 per cent. You can convert to dollars at Rs 43.23 spot and deposit those dollars at six per cent (which is the US one-year deposit rate) to yield $2.45. A year later, the spot rate must be Rs 111 to every $2.45 which works out at Rs 45.27. Alternatively, a forward trade on Rs 111 at the one-year forward of Rs 45.45 (Rs 43.23 spot plus 5.14 per cent premium) yields $2.44.
In an efficiently-traded currency, the differences should be marginal, as they are in this case. It's even more laudable since the rupee isn't fully conv-ertible so there isn't room for arbitrage to narrow differences.
This calculation is known as the covered interest arbitrage and occasionally yields large differentials between actual spots, for-ward premiums, and the suggested forward rates. Then the currency in question is mismanaged and due for a shock. In this instance, the numbers confirm each other and merely reinforce the likelihood of the rupee's continuing but controlled slide.