I told you so, didn’t I? About the rupee, I mean. On any number of television programmes in late March and early April, when the rupee was hovering around 45, and a wide range of banks — mostly foreign — were calling for 43 and even 42 by year-end, I pointed out that, with everybody positioned on one side, the bigger risk was that the rupee would weaken.
Of course, I didn’t know at that time that Greece’s budget problems were soon to trigger another wave of risk aversion. But I did believe that the dollar had bottomed out overseas and that it certainly could move up sharply on any dramatic trigger. So, while I wasn’t able to forecast specifically that the rupee would weaken to 47, I called a range of 43.50 to 48.50 for the rest of the year.
Like several other analysts, I had been concerned that the market had recovered from “nearly the worst depression of all time” so quickly. I was confounded by the fact that, after the credit crisis, the VIX, supposedly a broad-based measure of risk aversion, had fallen so rapidly. In fact, in October 2009, in a column titled “The Calm after the Storm”, I had recommended buying the VIX, which had fallen to around 21, since it seemed reasonable that global risk aversion should settle at a higher level than its long-term average (22, at the time) till markets really came back to “normal” and investors were once again on the prowl.
I was wrong, though, as the VIX continued to fall. The terrified herd mentality of global institutional investors poured money into risk assets from anywhere, with the dollar replacing the yen as the carry-trade currency of choice. Remarkably, even the news on November 5 that Greece had been fudging its budget figures, had no impact on the “new, improved” carry trade, with investors bidding up everything from the Australian dollar to oil, all over again.
On April 11, the International Monetary Fund and the European Central Bank announced the terms of a rescue package for Greece. On April 12, the VIX started to wobble from a three-year low (of 15.6), and the rest, as they say, is history. The VIX shot up to over 45, oil fell below $70, and the rupee plunged to an 18-month low of 47.50.
Note that back in mid-April, rupee volatility was extremely low — at-the-money option premia for six months and 12 months were down to 0.85 and 1.12, respectively. The good news is that many exporters, having learned their lessons over the past few years, had hedged quite a bit of their risk with plain vanilla options. Can’t say the same about companies with unhedged forex (FX) loans, though — several companies we spoke with remained curious but were more concerned about hedging their Libor risk than dollar/rupee, since, as everybody knew, the rupee could only strengthen, right?
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Well, wrong, as we have seen.
So, where do we go from here? Will the intrinsic strength of the India story continue to attract global investment flows, pushing the rupee higher again? Or, as we live through the second phase of The Big Global Funk, will investment inflows dry up for all risk assets, leaving our equity markets and the rupee weak and twisting in the winds of random events, both domestic and global?
I don’t know, but it would seem to me that with a second beating in less than three years, investors would stay risk averse for longer. Indeed, the “new normal” that many analysts wrote about could, finally, be upon us. This new normal would mean lower real (i.e., inflation-adjusted) return expectations and, shall we say, somewhat less enthusiasm for exotics.
The good news is that the US appears to be recovering steadily from its recession, which could, of course, mean somewhat higher US interest rates. Again, US President Obama’s financial regulation package, while weaker than I would have hoped, is stronger than anyone could really have expected. Clearly, the financial sector will be introspecting longer, which, too, should keep a lid on excessive risk-taking.
Europe — well, the good news is that now everybody knows that the Emperor has no clothes. There can be no sustainable monetary union without some real fiscal coordination — clearly, Brussels will be in the ascendancy. Buy real estate there. Structural change will be difficult, but the ongoing fusion of European characteristics is bound to continue.
The dollar will remain strong and the euro will remain under pressure, although bouts of volatility will continue to terrorise the currency markets, as they always have.
The rupee — well, I’ll stick to my earlier forecast: a range of 43.50 to 48.50 over the next 12 months.