The extraordinary rally in the rupee — it gained nearly 5 per cent in 10 days till October 8 — has once again shown up most people as rabbits frozen in the headlights of the future. To be sure, many companies have learned their lesson in part and so I find that the majority of our exporter clients have hedged a large part of their near-term exposures at good levels — 49, and, in some cases, over 50.
However, that doesn’t change the fact of the terror created by the move. How did it happen so suddenly? How could the rupee strengthen when the stock market was actually weak? How come RBI wasn’t more aggressive in protecting exports? And, most terrorising of all, is the rupee going to continue to strengthen from here?
Well, if you were watching the market very carefully, the move wasn’t all that sudden. Since it started recovering from its post-crisis low of 52 in March, the rupee had actually broken above 47 in June, and then had been bouncing around in a narrower range — between 47.50 and 49 — for the past few months. The falling volatility triggered a breakout signal on September 15, which suggested that the market could move sharply in either direction over the next few weeks.
Unfortunately, my market view has been that the dollar had been falling too long and that a correction was overdue. So, of course, I read this signal to reconfirm my view — that the breakout would be in the direction of a stronger dollar [weaker rupee]. Never fall in love with your market view, however lovely she looks!
How could the rupee fall if stocks were weak? Well, while there has been an extraordinarily strong correlation between equities and USD/INR for several years now, there have been periods when other factors have dominated one or the other and they moved in opposite directions. At the start of October, there was a strong focus globally on the fact that, with the exception of the rupee and the South Korean won, most emerging market currencies had been appreciating against the dollar. So, it could be that there were some large long rupee positions taken in the NDF market; this in turn created an arbitrage opportunity, with banks (and other players) buying cheap dollars offshore and selling them on-shore. We also note the huge single day volumes in currency futures, confirming that the move was largely speculative.
And where was RBI? Well, I’m sure they welcome a somewhat stronger rupee in view of the increasing concerns about inflation, and the difficulty of raising interest rates in a still tender economic scenario. Again, since the decline in exports is entirely because of the collapse in global demand, rather than any major issues with competitiveness, a modestly stronger rupee should not pose too much of a problem. The real problem that exporters face is with managing volatility, since many of them now try and build the cost of risk into their product pricing. Higher the volatility, higher is the cost of risk — and to protect competitiveness, exporters need to hedge more than they used to. The good news, as I mentioned above, is there are signs that this is already happening.
Finally, of course, we come to the million — or, in this day and age, I guess I should say trillion — dollar question. Is the rupee going to strengthen from here? There are all sorts of forecasts calling for 45 by December or 43 by March. I note that many of these same forecasters were calling for 55 or 57 not so long ago. In other words, most forecasters simply go with the trend and extrapolate, which is why I seldom go out on this kind of a limb.
There is, however, one alarming forecast that is worth reporting, since I have heard it from several sources. The easiest-to-recognise pattern in the arcane arena of technical analysis is the “head and shoulders”. The rupee’s movement over the past few months appears to be forming just such a pattern (in reverse), with the head at the low of 51.95 and the two shoulders at 46.80. In the event, this level (46.80) is conclusively broken, it would signal a move towards 41.60. Yes, you read that right — 41.60!
If it doesn’t break that level, all bets are off and we could see some retracement towards its earlier lows.
Clearly, we are at a key nodal point; my sense is that RBI will be much more aggressive if the current upward pressure remains.
In any case, all of us rabbits need to get off the road.
