As regards the rupee, the next five years will look more like the very recent past — high volatility and a wide range (say, 40 to 55 against the dollar).
A decade and more ago, everyone had no doubt that the rupee could only get weaker. And everyone, for the longest time, turned out to be correct. Since Independence, the rupee fell and fell and fell (with only an occasional hiatus). And the conventional wisdom got stronger and stronger and stronger.
And like everyone else, I was no exception.
In 2001, when the rupee was 47 and falling, I remember scoffing (discreetly, of course) at a client who told me, “The rupee will never ever hit 50”, even though his reasoning was extremely sound. As it turned out, he was able to laugh all the way to the bank when the rupee bounced off 49 (in mid-2002), and started to strengthen. I don’t know if he had sold any options at 50, but I do know that he had kept his large dollar liability unhedged.
This — both the fact of the turnaround and his strongly articulated views — made me start to question my conventional thinking, and about a year later, I realised that as the India story was finally taking hold in global minds and, much more importantly, in Indian minds, the rupee could — and, indeed, should — actually start to strengthen.
In 2003, by which time the rupee had strengthened back to 47, I said in a newspaper interview that I thought the rupee would reach 35 in five years.
Most people thought I was nuts, and, since I am a reasonably easy guy to get along with, many people even told me so. Conventional wisdom — that the rupee will always depreciate — continued to rule the roost.
By mid-2007, however, with the rupee surging towards 40, I was reminded, first by Bhavani, who runs our Bangalore operation, of my “crazy” forecast. As the rupee continued to strengthen, breaching 40 for the first time in September of that year, I was being feted by many in the media for my foresight. The truth, of course, is that I didn’t really know that the rupee would reach 35 by 2008 — I was merely trying to break through the deeply entrenched view of a forever-weak rupee.
As it turned out, the rupee did not reach 35 in 2008 — pity about that, I would have bought a billboard on Marine Drive if it had.
However, in the dramatic rush towards 35, the entire mindset of the market changed.
By February 2008, with the rupee on fire despite RBI’s histrionic efforts to cool it, everybody and her brother became completely convinced that the rupee would reach — and, possibly, breach — 35 in no time. Companies sold their exports forward to two, three, sometimes five years; banks sold multiple structured products to enhance returns on these sales; the market was in a frenzy.
Of course, the wheel turned suddenly, and, by mid-2008, all of these exposures went heavily out of the money; and when the global crisis really hit, the rupee tumbled through the rubicon of 50 to the dollar. While it has recovered a bit, it is interesting that the new conventional wisdom that took hold in early 2008 — that the rupee can only strengthen in the medium term, the India story, the India story — remained, and remains, firmly intact.
Some exporters are again looking at selling far forward, and there are many companies with foreign currency borrowings, most of which were drawn down when the rupee was around 40 to the dollar, who are waiting patiently and without too much concern (particularly since ICAI has provided a reprieve from AS-11 accounting hell) for the conventional wisdom to play itself out.
While I must admit that the tea leaves are much more difficult to read than they were in 2003, I am getting a sense that this conventional wisdom, too, may be upended over the next couple of years by a likely, very necessary and sustained surge in imports. In 2007, India’s imports were a mere 27 per cent of GDP — that’s lower than all except two (Brazil and Russia) of the 14 emerging markets we are studying.
Thus, as we get back on a high-growth path and continue to globalise, imports will rise dramatically — over five years to, perhaps, as high as 40-45 per cent of GDP (the average import intensity of reasonably globalised emerging economies). This will counterbalance the expected increase in investment flows, on which the conventional wisdom is predicated, which suggests that the next five years will look more like the very recent past — high volatility and a wide range (say, 40 to 55) — than the benign strengthening trend that many are expecting/hoping for.
Unconventional wisdom, anyone?
