When I was a child, I read a famous story about Chicken Little, a little chicken who was wandering around the farmyard one day when an acorn fell on his head. Chicken Little was stunned and thought the sky was falling. He ran upto the horse in a panic, “Horse,” he said, “the sky is falling”. The horse said “Neigh” and went back to his hay. He skittered over to the cow. “Cow,” he said, “the sky is falling.” The cow said “Nooooo”, and went back to her grass. He scampered over to the pig, “The sky is falling,” he squeaked. The pig paid him no attention and went back to his important business. He found the duck and said, “Duck, duck, the sky is falling.” The duck said something rude and swam away.
Finally, Chicken Little ran into the farmhouse, flapping his little wings, hyperventilating “the sky is falling, the sky is falling.” The cook took one look at the silly little chicken, grabbed him and tossed him into a pot of water boiling on the stove.
I thought of this story when I read the most recent forecasts for the rupee reported in the press. The accompanying chart shows the last four forecasts for December 2017 (made in Dec 2016, March 2017, May and just last week). It is clear that the forecasters—or, certainly, the most extreme ones—are like Chicken Little, and companies need to avoid getting stampeded by their histrionics, or they may end up in the cooking pot.
Our own approach to December 2017 is as follows: For exporters, draw a line in the sand (stop-loss) at 63.75 to the dollar; hedge at least 35% immediately (at the current forward rate of 65) and monitor the MTM daily. If/when the MTM improves by “x” paise, hedge a further y% and continue this process for each subsequent improvement in the MTM. If, however, the rupee continues strong and premium decay brings the stop-loss too close for comfort—say, the MTM reaches 64, exit the exposure. These parameters need to be set for best efficiency (which is part of what we do), but the approach should be based simply on the stop-loss, the lock-ins and the market as it is, not as some Chicken Little thinks it will be.
The most important part of this exercise is setting the stop-loss and, of course, ensuring you act if it is threatened. It is usually best to have some sort of analytic signal (like VaR) rather than leaving it to defining “too close for comfort”, which could turn out to be yet another Chicken Little recipe.
For importers, who are certainly sitting pretty, draw a line in the sand (stop-loss) at 66.10 to the dollar or so, and sit tight till October-end (unless, of course, the stop-loss is hit). After that reduce risk in 25% chunks following a structured (non-Chicken Little) process. There are many alternative ways to do this, and, again, they should be based on what is actually happening in the market not some view or expectation. Ideally, the exposure should be fully hedged by early December.