The drama last Thursday evening, when RBI first intervened selling dollars to soften up the market, and then pulled out the long overdue sledgehammer requiring banks to trim their overnight long dollar positions, has, at least, put a brake on the rupee?s terrifying decline. In fact, the drop?from 54.30 to 52.75?reverses about half of the ?excess? depreciation that has been caused by the excessive short positions in the market.
To my mind, RBI should have been even more aggressive and followed up the directive with more intervention on Friday, which could well have pushed the rupee back above even 52 to the dollar. In particular, they should have?and still can?intervene before the noon fixing, so that the NDF settlement gets pushed lower. If the intention is to try and hurt speculators, this would be an obvious step.
The good news is that RBI?s intervention process appears to have become cleverer?rather than asking for prices and then saying ?yours?, nationalised banks were hitting existing quotes, taking the market more by surprise, resulting in more bang for the buck.
Of course, the game is far from over. While the cap on long positions will keep the rupee?s weakness controlled, the mayhem in the equity markets on Friday (clearly, a year-end book closing exercise) suggests that at least till the turn of the year there won?t be any meaningful inflows, and the rupee will have to fend for itself balancing domestic supply (thin) and demand (huge). Thus, the rupee will probably remain pressured requiring RBI to maintain control.
Vigilance is even more critical since markets, both domestic and global, are thin (and thinning further as the year ends) so all moves will be exaggerated.
Going forward, I see continued high volatility, with the bigger threat being dollar strength. I noticed last week that the dollar was strengthening despite the fact that the VIX?the key indicator of global risk aversion?was falling. Clearly, the game that had been playing out since September?when markets got worried about Europe, they ran to the dollar, when it looked like things might settle, they ran out of the dollar?has changed. The dollar?s current strength appears to be ?fundamental? and we may well be on the cusp of a medium-term dollar rally?US economic stats are already showing a little improvement and, once the market jumps on this, look out.
On the other side, we need to also prepare for a possible brief euro relief rally. My reasoning is that the VIX cannot fall if the market believes Europe is going to hell. We may well have seen the worst of the European crisis, and, while the medium-term implication of this is a (much) weaker euro, market realisation, which may come early in the new year, could lead to a sharp rally. Watch the VIX.
RBI, of course, needs to be ready for all this with its barrels fully loaded.
A word on the two missing cheers.
First of all, Thursday?s directive had, in my view, a horrendously misplaced focus on limiting cancellation and rebooking of forward contracts. While RBI certainly has access to much more information than I do, I can confirm that not a single exporter I know has been cancelling its forward covers to rebook?I mean who is going to take a cash hit of 5 or 6 rupees (assuming the covers were at 46 or 47 and the cancellation at 51) to express a view of further rupee weakness. Indeed, I can?t imagine anyone, however risk-prone they may have been in the past, taking on risk in this market by choice. Granted there are a few large corporate trading desks that would likely have been cancelling and rebooking, but the volumes are marginal?probably no more than a few hundred million total, which is infinitesimal in comparison with bank positions and, of course, the existing shorts?and, importantly, no higher than they were in the past.
In other words, this move, which will squeeze liquidity and make risk management much more difficult, will achieve precious little in terms of curbing speculative demand. Companies who run sensible hedging programmes sometimes need to cancel hedges (if, say, the underlying order is cancelled); if these hedges are in the money, there is no justification whatsoever of stealing this gain from them. Again, many companies use the past performance limits to hedge to reduce risk on expected business exposures?reducing this limit will, again, make it more difficult to run sound, well-established hedging programmes. Finally, the circular is silent on rollovers (other than for FIIs), so I am assuming that if a genuine exposure is delayed a company will be able to roll over a hedge. Basically, this part of the directive is unnecessary and confusing. These curbs should be revoked immediately.
The last missing cheer, of course, is for the missed CRR cut. While signalling a change in stance is all very well, you can?t sit back and watch?you need to be pro-active, particularly when the market is on a rampage. An off-meeting CRR cut followed by more FX intervention will be just the ticket to bolster RBI?s very slowly recovering credibility.
And, earn me a little well-deserved R&R in Goa.
The author is CEO, Mecklai Financial Services