Boy, these past couple of weeks have been a riot, with everybody talking about 55, 57, even 60 rupees to the dollar. It’s as if the market suddenly woke up and noticed that India has a large and growing current account deficit; that global markets are under severe stress, with the focus primarily on European sovereign debt but, from time to time, switching back to how much US politics is beginning to resemble Indian politics; and, of course, Indian politics.
Other than the rupee’s sharp slide – which began, by the way, at the start of September – all of these issues have been around for well over a year. So, it is curious that everyone is suddenly talking about numbers they never even dreamed of six months ago.
The truth, of course, is that none of them really has any clue as to what the rupee will be in a week, let alone six months. Indeed, the near-unanimity of frighteningly bearish forecasts may well be a strong positive for the rupee — as we have all found out time after time, the market’s job is to prove the largest number of well-intentioned, smart people wrong.
So, where should the rupee be in six months? Or, more importantly, where will it be in six months? Of course, I, too, don’t know, but I’d like to lay out some thoughts.
First of all, from January to August this year, the rupee hovered between 44 and 46. The important point is that, during this time, there was no discussion whatsoever (at least, I didn’t see any) about the rupee being uncompetitive for either exports or imports. We appeared to be at a “reasonably valued” rupee. (To my mind, it is much more meaningful to use such empirical evidence rather than analytic constructs like REER, or Real Effective Exchange Rate, to assess where the rupee should be.)
Since September 1, the dollar started strengthening overseas with global risk appetite falling. Risky assets – including most non-dollar currencies and all equities – declined, but at different rates. Indeed, when the euro was falling, the rupee largely mirrored its path; however, when the euro got a brief lease of life – during most of October, for instance – the rupee was unable to jump on the risk-on bandwagon. This was primarily because the domestic foreign exchange market was heavily short dollars, a direct result of the long period of low volatility (the calm) that preceded the break-out (the storm). If we had a better-structured market (or, indeed, if businesses had followed structured risk management processes rather than responding logically to market movements), the rupee today would be around 49.50 rather than 52.50.
After an unbelievably long time, the Reserve Bank of India (RBI) has finally taken some action, and appears to be more proactive in managing this situation. Of course, the rupee is still on the ropes, since the twin pressures of a weakening euro and a still heavily short market have not gone away. I believe the RBI should be more aggressive, perhaps requiring banks to not hold long dollar positions overnight. This would certainly create some upward movement in the rupee, at which point the RBI should intervene strongly and try to recover some part of the Rs 3 gap I mentioned earlier.
On the other hand, it makes no sense to fight the market, and if the dollar does continue to strengthen overseas, the rupee will weaken further.
So, assuming the RBI remains meaningfully engaged, the real question is what the dollar will do overseas. The good news – and, for once, I think the entire country will agree that a stronger rupee would be a good thing – is that despite the creeping terror of European sovereign bond yields, the euro appears unwilling to give up the 1.30+ level. Again, I just read an article in The Economist all but writing the euro’s obituary, which makes it more or less certain that the euro will survive.
On the other hand, I am extremely worried about the volatility of gold, and the fact that it has been rising unilaterally — the volatility of other assets, notably currencies, has not risen anywhere near as sharply as it usually does when gold goes nuts. This suggests that we may be in for a dramatic move in gold, and my sense is that it is more likely that gold will head towards 1,200 than 2,000. The former means the dollar will strengthen sharply and the traumatic forecasts (of 56 or 58) will come true; the latter suggests we may see some reversion to sub-50 levels.
In either case, the action plan should remain unchanged. Mark your unhedged short positions to market; set a worst-case stop-loss; definitely buy some dollars today, using forwards, options or call spreads (if you are in the RBI’s preferred list); and monitor your exposures like a hawk, hedging partly whenever the market moves favourably or completely if it breaches your stop-loss.
