Dealing with the unknown unknowns

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Published: June 9, 2020 4:45 AM

The big question, of course, is why is the rupee so “strong”? Well, the obvious answer is that there is more demand for rupees than supply.

Thus, while the rupee appears in reasonably good shape in the near term, it is—perhaps, more than usually—dangerous to ride that horse without any protection.Thus, while the rupee appears in reasonably good shape in the near term, it is—perhaps, more than usually—dangerous to ride that horse without any protection.

The rupee has held above its all-time low (of Rs 76.78) for nearly 50 days so far; over the past decade, the shortest period of rupee steadiness/strength after which it turned lower again was 53 days; the longest was 273 days, and the average was 172 days. Thus, if the rupee replicates its shortest stint, it would start to turn lower later this week, which doesn’t appear likely right now. It could, of course, turn at any time, but if it stayed steady for the average period, it would begin to fall in October this year, which is right before the US election, which could certainly be a driver of increased uncertainty.

Another curious point is that during its long falling and rising path, the rupee has never recovered to a level better than the previous low (Rs 74.45)—today, it is almost there (its recent high was Rs 75.25). But, as we know, history never repeats itself exactly and, already there are forecasters (BofA) calling for Rs 74 to the dollar in the near term.
The big question, of course, is why is the rupee so “strong”? Well, the obvious answer is that there is more demand for rupees than supply; put differently, there is more supply of dollars than demand for them.

Dollar demand is down because growth is down and imports are down—exports are also down, but, being lower, by a much lesser amount. Over and above sharply lower growth, low imports reflects lower oil prices (which have averaged $43 a barrel this year so far as compared to $65 a barrel last year); however, it is worth noting that oil prices appear to be ticking up. Nonetheless, there are analysts who are looking at India running a current account surplus of $20 bn this financial year.

On the capital account side, remittance outflows are down sharply, only partly balanced by lower inward remittances, which would result in a net decrease in dollar demand. Additionally, dollar supply is up because, despite the fact that FPIs were pulling money out in droves, there has been a huge amount of FDI (Reliance?) over the past month.

As a result of all this, RBI has had to buy dollars to prevent the rupee strengthening even further—reserves have risen by over $10 bn between February 21 and May 22 (while FPI inflows have fallen by $23 bn over the same period). The NDF market, too, has steadied with the one-month forward on-shore and off-shore largely the same—this may have to do with RBI’s sharp attack on March 13, when it bought $500 mn off-shore. Further, the opening up of the NDF market to Indian banks (at GIFT) suggests that RBI may use this channel for continued intervention, whenever the spread gets too wide. This, too, may support the rupee.

Again, FPI money has been coming in strongly, with nearly $3 bn of inflows since May 22, reflecting the increase in investor risk comfort. Global equity markets, which are up over 40% from their March lows, are riding high on the continued belief that free money—the US is almost at zero interest rates as well—will support equity prices, and the hope that the re-opening of economies from the lockdown will be successful and fast.

The correlation between movements in the Dow and FPI flows into India, which generally ran at about 50%, has increased to over 85% over the past two months, confirming that the near-term future of the rupee will be even more intimately linked with global risk conditions than earlier.

The Dow has hurdled over several resistance lines over the past couple of weeks and now appears well-set above a rising support line. However, the market is certainly frothy and there are several hedge funds which are looking for another sharp decline to shake things loose. There could be any number of triggers—continued weak growth and job losses despite the reopening, a resurgence of the virus, a sharper (than expected) spike in oil prices, the China-US spat, Trump falling apart before or during the election, and, of course, other unknown unknowns.

Thus, while the rupee appears in reasonably good shape in the near term, it is—perhaps, more than usually—dangerous to ride that horse without any protection. Importers should hedge some part upfront and monitor the open exposure with a very disciplined stop loss—our hedge programme has worked quite successfully with this process, saving 1.9% pa of funding costs on average over the last three years (including the period of the sharp collapse).

Exporters should, of course, be very careful about their business forecasts, and with reasonable conservatism they should hedge somewhat more aggressively than importers—again, our export programme has, over the past five years, delivered strong average savings against both a 50% hedge (0.78%) and staying unhedged (1.56%).

 

CEO, Mecklai Financial. Views are personal

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