There is a famous economic theorem called the Impossible Trinity, or The Trilemma. This states that it is impossible to maintain a stable currency rate, have an independent monetary policy and allow for free capital movement at the same time.
The Reserve Bank of India (RBI) tries to finesse its way around this. India has an independent monetary policy. RBI sets money supply and policy interest rates as it pleases. Some freedom is allowed in capital movement. But, there are controls. The rupee is traded heavily on the basis of what is called a "dirty float": RBI intervenes as and when it chooses.
The RBI, therefore, maintains some control over exchange rates and there are capital controls. But this still means that rupee forex rates fluctuate a lot. The RBI has to allow that fluctuation, unless it is prepared to impose more rigid capital controls, or stop setting independent monetary policy.
Between January 1, 2014 and February 02, 2016, the rupee has traded down 6.9 per cent against the US dollar. During this period, it has lost 5.42 per cent versus the yen and 1.44 per cent against the yuan. But, it has gained 4.16 per cent versus the Euro and 2.15 per cent against the pound sterling.
These movements are driven by relative rates of inflation in the respective nations, by the trade balances between nations, by differences in real interest rates, etc. Trader-projections are quite influential where such movements are concerned.
Currency fluctuations have multiple impacts on trade and on the balance sheets of corporate groups with exposures to several currencies. The recent decision by the Bank of Japan (BoJ) to impose a negative policy interest rate, in addition to a quantitative expansion programme, should lead to the yen falling versus most world currencies, including the rupee. Indeed, the yen has fallen versus the rupee since BoJ announcement. RBI's decision to hold rupee policy interest rates will widen the gap between negative or very low yen rates and prevailing rupee rates.
This has interesting consequences for corporate groups like Maruti, Ranbaxy, Motherson Sumi, Asahi India, etc. These are all companies that have Japanese ownership. They source imports and pay royalties to their respective parents. In addition, there may be Indian corporate groups that have yen-denominated loans.
In Maruti, for instance, about 25 per cent of costs are yen-denominated. A weak yen is generally good for Maruti. Its cost-structure and profitability improves as the costs reduce in rupee terms. A strong yen on the other hand, is bad for it because that means higher payments to the parent, Suzuki, and if Maruti passes on the cost to buyers, the cars become more expensive. Similar favourable dynamics operate for other companies with substantial yen outgos, including corporate groups with yen-denominated loans. Exporters to Japan will, of course, welcome a stronger yen.
If the yen does continue to depreciate to some extent, there will be several types of potential trades. One consists of long yen-rupee positions hoping for direct gain in the futures and options trades as more yen will be available for the same rupees. Another possibility is considering going long on entities like Maruti, Ricoh, Motherson Sumi, Ranbaxy. Of course, these firms will have to exploit the currency benefits, but it should cut their costs.
Incidentally, most analysis of the proposed bullet train between Mumbai and Ahmedabad have glossed over this not-so-minor detail of currency movement. Japan lends $12 billion (Rs 81,609 crore) equivalent to be paid back over 50 years at a nominal interest rate of 0.1 per cent. If the loan is yen-denominated, the real danger is currency volatility. How much could the rupee fall (or gain) versus yen over 50 years?
The Reserve Bank of India (RBI) tries to finesse its way around this. India has an independent monetary policy. RBI sets money supply and policy interest rates as it pleases. Some freedom is allowed in capital movement. But, there are controls. The rupee is traded heavily on the basis of what is called a "dirty float": RBI intervenes as and when it chooses.
The RBI, therefore, maintains some control over exchange rates and there are capital controls. But this still means that rupee forex rates fluctuate a lot. The RBI has to allow that fluctuation, unless it is prepared to impose more rigid capital controls, or stop setting independent monetary policy.
Between January 1, 2014 and February 02, 2016, the rupee has traded down 6.9 per cent against the US dollar. During this period, it has lost 5.42 per cent versus the yen and 1.44 per cent against the yuan. But, it has gained 4.16 per cent versus the Euro and 2.15 per cent against the pound sterling.
These movements are driven by relative rates of inflation in the respective nations, by the trade balances between nations, by differences in real interest rates, etc. Trader-projections are quite influential where such movements are concerned.
Currency fluctuations have multiple impacts on trade and on the balance sheets of corporate groups with exposures to several currencies. The recent decision by the Bank of Japan (BoJ) to impose a negative policy interest rate, in addition to a quantitative expansion programme, should lead to the yen falling versus most world currencies, including the rupee. Indeed, the yen has fallen versus the rupee since BoJ announcement. RBI's decision to hold rupee policy interest rates will widen the gap between negative or very low yen rates and prevailing rupee rates.
This has interesting consequences for corporate groups like Maruti, Ranbaxy, Motherson Sumi, Asahi India, etc. These are all companies that have Japanese ownership. They source imports and pay royalties to their respective parents. In addition, there may be Indian corporate groups that have yen-denominated loans.
In Maruti, for instance, about 25 per cent of costs are yen-denominated. A weak yen is generally good for Maruti. Its cost-structure and profitability improves as the costs reduce in rupee terms. A strong yen on the other hand, is bad for it because that means higher payments to the parent, Suzuki, and if Maruti passes on the cost to buyers, the cars become more expensive. Similar favourable dynamics operate for other companies with substantial yen outgos, including corporate groups with yen-denominated loans. Exporters to Japan will, of course, welcome a stronger yen.
If the yen does continue to depreciate to some extent, there will be several types of potential trades. One consists of long yen-rupee positions hoping for direct gain in the futures and options trades as more yen will be available for the same rupees. Another possibility is considering going long on entities like Maruti, Ricoh, Motherson Sumi, Ranbaxy. Of course, these firms will have to exploit the currency benefits, but it should cut their costs.
Incidentally, most analysis of the proposed bullet train between Mumbai and Ahmedabad have glossed over this not-so-minor detail of currency movement. Japan lends $12 billion (Rs 81,609 crore) equivalent to be paid back over 50 years at a nominal interest rate of 0.1 per cent. If the loan is yen-denominated, the real danger is currency volatility. How much could the rupee fall (or gain) versus yen over 50 years?
The author is a technical and equity analyst