Recent currency wars and its power to change asset prices globally have highlighted the usefulness of currencies for trading and investment. Mega-investors like George Soros made their fortunes trading in currencies. Currencies are also more liquid than any other asset with volumes higher than the combined volumes of equities and commodities.
Currency trading is gaining importance in India after its debut as a trading instrument in the form of futures and options. This is an important milestone towards our goal of full convertibility. Currency trading is probably also more logical than any other asset as its pricing is always quoted relative to some other currency. At present, four pairs are quoted on Indian exchanges, all against the rupee: US dollar, euro, UK pound and Japanese yen and run with contracts from one month to a year ahead.
Because currency values are quoted with respect to other currencies, it is necessary to understand and track the reasons which affect the relative prices. Since India is doing well and the US was in a recession, we saw the USDINR value go from Rs 49 to the rupee up to Rs 43 and then back again to Rs 46 and then trending towards 43 again. Several short and long-term factors affect these rates.
Short-term interest rates, inflation, RBI interventions, US economic data and even crude oil prices (which form a large part of our import bill) are important in the near term. Interest rates, money supply in each country and domestic monetary policies, balance of payments and trade deficits will play a role in the long-term outlook.
Trading currencies is similar to trading any other asset. Therefore, when demand for dollar goes up due to its requirement to buy crude oil from international markets then the dollar will become more expensive vis-?-vis the rupee. In a globalised world where so many products and services are traded across borders, currency trading also serves an important function of derisking the business by hedging the currency suitably.
So, if Infosys gets paid in dollars and/or euros for services given abroad, they will have to freeze the price of the dollar and euros which they will get now and in the future using currency futures and options markets now available in India on NSE and Mcx-Sx. At present done via OTC trades in banks, the hedging business is moving quickly towards currency futures exchanges due to the benefits of transparency, consequently cheaper hedging and novation from the exchanges.
Priming your knowledge base in currencies is fairly easy. Most likely, currency wars will continue till such time no global solution is proposed and accepted. While gold remains a safe place to park money at the moment, that will change too at some point. Your portfolio can be said to be truly balanced only if it contains currencies too.
So it makes sense not to put all your eggs in one basket and spread out over different assets including currencies other than the dollar. That?s because in our increasingly connected world, what happens in Moscow, Tokyo and Beijing is just as important as the markets in New York, London and Singapore.
Disclaimers in place, here?s a brief view on the major currencies. The dollar continues its see-saw movement buffeted by the stimulus on one side and a weak euro on the other. It?s a dynamic situation as the US government pulls all stops to strengthen its economy. Euro is likely to be weak till the PIIGS (Portugal, Italy, Ireland, Greece, Spain) economies strengthen. So powerful is the currency equation that there have been statements by top European leaders that if the euro fails then Europe fails ? which means that they will do everything to turnaround the economies of these countries. Great Britain, too, is going through a financial crisis and the pound, too, has been under pressure except for recent momentum.
The Japanese yen has been strong in the recent turn of domestic and global events and though the upside looks capped, the price trajectory will depend on a multitude of factors including how much its exports are affected due to a strong yen.
Competitive devaluation of currencies by their governments is a reality today as each country tries to export its way out or recession.
Meanwhile, commodity currencies like Brazil, Australia and even Canada are doing well as commodity prices rise. Financial markets in 2011 are likely to be underlined by currency volatility globally and currency futures and options in India will be useful for hedging and those with foreign currency exposure can look to lock in their capital to evade volatility while it is a great opportunity for those wanting to trade or invest in this new asset.
The writer is president, Religare Commodities