The rupee has been above (stronger than) its opening all-time low of 76.77 for 14 straight trading days, and is also holding above the long-term support line starting from the low of 68.45 (hit in September 2013). The chart shows that whenever the rupee has sustained above its then all-time low for more than two weeks, it has stayed firm for quite a while longer.
Since 2011, there have been seven episodes of sharp rupee declines and it has never turned lower after recovering from the low for so long. The shortest period of rupee strength from an all-time low was 49 days (back in December 2011), and the shortest period within which it revisited those lows was 109 days later (again, way back in 2012). It has also had very long periods of strength (before crossing the earlier low)—as long as 2.5 years (from Sep 13 to Mar 16).
While we know that history never really repeats itself, reading this data begs the question (that so many are asking): Could we be entering into a period of rupee ‘strength’?
On fundamentals, which are today primarily driven by the coronavirus, there is little chance for sustained strength anywhere in the world, least of all in India, where the government’s efforts have been tragically inadequate, judging from the horrifying collateral damage to millions of daily wage earners, and people who were self-employed or had jobs in small enterprises.
On the other hand, and speaking purely technically, the NDF market has quietened down substantially, with the 5-day average of the spread between the off-shore and on-shore markets coming down to near zero, which was its level when the rupee was steady. This was certainly at least partly driven by RBI’s surprise intervention in the NDF market on May 11, when the spread actually changed direction—dollars were hugely cheaper on-shore than off. To be sure, the spread has climbed a little bit again and it remains to be seen whether RBI will remain active off-shore to keep ‘speculative’ sentiment in control.
Another curious issue is that RBI’s reserves have risen quite dramatically—by $7.5 billion—between the end of March and early May, despite the fact that FPI inflows remained negative during the period (not as hugely as in March, but still negative). Some of this was due to the increase in value of RBI’s gold holdings as also its non-dollar reserves (since the dollar strengthened by about 1% during this period).
Still that leaves about $4 billion that RBI has bought in the market, preventing the rupee from getting stronger; it has also been selling forward, perhaps to prevent the premia from rising too high under negative sentiment. Despite lower oil prices, trade deficit is higher, with both exports and imports down sharply; and inward remittances and outflows under the LRS scheme are both down. Perhaps RBI’s purchases reflect bunched investment inflows (Reliance?).
On the downside, rupee volatility is still climbing, although it seems to be showing some signs of a peak. We would need to see another week or so of a steady rupee before we could think of playing the rupee strength card definitively.
Of course, as we all know, markets are strange beasts, and trying to make sense of them is a fool’s errand—I have learned through long experience that all the perfumes of Arabia will never sweeten the smell of market views gone wrong. This is why we always recommend a conservative approach to hedging risk, setting sensible expectations—trying for the big hit is a sure recipe for disaster. Rather, you need to set modest targets and hedge systematically.
Our hedging model for imports (MHP-I), which has been in use for nearly five years, delivers what are to my mind reasonably good results. One client, who has been using it since September 2017, has saved, on average, 22 paise per dollar for exposures maturing up to October 2020, as compared to zero risk (viz., hedging on Day 1).
The model is conservative, yet outperformed both zero risk and 100% risk (staying unhedged, which, of course, is never recommended). While it is not perfect—the rate was worse than zero risk as much as 34% of the time (1 in 3 months)—the hedging structure ensures that ‘losses’, when they occur, are modest, and the gains are much higher. The monthly funding cost was higher than 8.5% p.a. only four times, while the best funding cost was negative 20% p.a.!
Like I said, modest targets and reasonable performance are the hallmarks of sustainable risk management.
The author is CEO, Mecklai Financial. Views are personal
