Boy! What a week? The rupee continued falling sharply in the face of continued RBI intervention, losing another 1.50/$ to close the week around 74/$. But the real trauma was in the equity market, already nervous about the contagion in the NBFC sector, which was spooked by the apparently free-falling rupee; global investors exited in droves as the Sensex fell by over 5% over the week.
I’m normally not too perturbed by markets—we follow a structured approach to hedging which keeps you calm and generally delivers reasonable results. But with rupee volatility at its highest since the taper tantrum and all models loudly blinking STOP LOSS, I found myself losing sleep (and hair) after a very long time.
More power to RBI, then, who, in Friday’s monetary policy, kept its head when all around were losing theirs and maintained status quo on the repo rate, despite the majority of market analysts (self included) looking for rates to be hiked by 25 to 50 bps. The rupee, remarkably, stopped falling, settling just south of 74; equity markets, however, remained terrorised and lost another 1% after the policy.
The weekend seemed to calm things down further and the rupee opened quietly on Monday, as did Dalal Street.
Significantly, equities showed a huge amount of resilience when, after tanking in sympathy with the brutal sell-off in Chinese equities, they recovered ground to end in positive territory.
Most bets, though, are that this hiatus is not the end of the trauma, which began several months ago (in April), when oil prices rose above $70 per barrel and pushed the rupee out of the 63-65 range it had held for over a year. When oil broke through 75 in late August, the rupee fell—despite more or less continuous RBI intervention—through its long-term all-time low (of 69); now that oil, having crossed 80, is threatening 85, the rupee is threatening 75. Interestingly, equity markets only cracked in September, when the rupee fell below 70. So, how will it play out from here?
Well, there are any number of forecasters who are looking for a pause in the rupee’s decline—some even believe it could strengthen back to 72 or a bit better—before another wave of global volatility, whether driven by another spike in oil prices or continued firming of US rates or hardening of the US/China trade standoff, takes charge and pushes it down to another all-time low (levels vary from 81 to 85).
RBI will, of course, be on full alert. In addition to the nearly $400 billion of reserves, it has several other tools that it can use to at least steady the market. They have been prudent in not pulling these out when the market was in full flight.
But if the rupee were to remain steady (say, around 74) for another week or two, it may be a good idea for RBI to push one of its most powerful buttons: Requiring commercial banks to cut back their long USD overnight positions to zero. Over the past few months, every commercial bank with any commercial sense at all would have loaded up on dollars. The overnight limits of all the commercial banks probably total around $1.5-2 billion and it is likely that banks are all in at that level. If they were compelled to offload all of these into the market in one day, and particularly if RBI were to immediately chase this with $200-300 million of its own dollar sales, it would quickly chase the rupee back to (perhaps) 71.
Timing the use of this tool is important. With our elections coming up and the fact that global volatility could surge at any time, it is better if this were implemented sooner rather than later. This would also give investors a sense that RBI is working to a plan and not simply responding to market pressures.
There are several other things both the government and RBI can do. Getting PSU NBFCs (like PFC, IRFC, etc.) to draw down their committed lines of credit from multilateral institutions and place them on deposit with the government is one; this could bring in $10-15 billion quite quickly. And, of course, there are the other standard tools like NRI bonds and interest rate hikes. Calibrating the timing of these would be important.
But all this would only be buying time. Our fundamental ailment is weak exports, and the current negative sentiment is only a symptom. Fixing the disease will take time, and it is critical that during this period, starting immediately, the government should announce a credible panel—rather like the one they set up for IL&FS—of senior business leaders to develop a framework for increasing exports. While many of the recommendations will not be immediately implementable—it is the political season, after all—having them out there would at least provide investors a sense that there is a roadmap.
Real recovery will, of course, have to await the calming of global winds, the sustained rollout of export development plans and our next election. It is, perhaps, significant that India has prospered most under coalition governments.
-The writer is CEO of Mecklai Financial