My last column (October 1) was titled Is the Dollar Rally over? Since the start of 2022, the dollar had strengthened by 18.7% against the euro (till September 28), 28.5% against sterling (till September 26), and 30.4% against the yen (till as late as October 21). Since those respective dates, it has fallen by 4.5% against the euro, 10.1% against sterling, and 2.9% against the yen. Thus, over the past month or so, the dollar has stopped rising-indeed, it has fallen, and in some cases quite a bit. Of course, whether this is merely a pause for breath or a turning point from which is actually falls further or, at worst, doesn’t climb any more, is anyone’s guess.
I would point out that most of the factors that were driving the dollar’s rise have by now been already built into the market-from rising inflation and rising US interest rates to the difficulties (on energy prices and everything else) being created by the Russian invasion of Ukraine and the Chinese slowdown. Again, while US (and global) equities fell sharply in sync with the dollar’s rise, by early October, even as it seemed the dollar was turning, most of the pundits went big on forecasting further major equity collapses-for instance, the chairman of one of the largest US banks said (on October 11) that the Dow could fall a further 20%. In the event, the Dow has risen by 12.5%.
Also read: Hunger index reads India wrong
It certainly smells like some kind of turning point.
The rupee, of course, is a late bloomer. It fell by only 11.6% against the dollar since the start of the year till October 20 (about the same date as the yen reached a nadir), and has recovered a miserly 0.9% since then. To be sure, the rupee does march more to its own tune than other currencies do, but the off-dollar forces continue to appear positive for the rupee-the Diwali season saw substantive buying, particularly of gold; and our equity markets are again testing 60,000 as both domestic and global investors appear to see India as one of the few reasonable bets in the world today-reinforcing the suggestion that the rupee may also have seen at least a short-term bottom.
The graphic, which shows the decline in the rupee (in terms of rupees per dollar) over the preceding 12 months, also appears to indicate that the current decline (of around Rs 8) may be coming to the end of its rope. To be sure, there have been larger 12-month declines (nearly Rs 10 back in 2018), but in all cases, the rate of decline has started to reduce from around these levels. However, the line in the graphic tends to recover slowly and in fits and starts; thus, it is unlikely that the rupee will surge higher suddenly.
In November and December last year, spot USD-INR averaged about 75, ranging between 74 and 76.25. So, if the rupee held at the Rs 8 12-month decline, the range over the next 2 months could be 82 to 84; if the rupee started improving (as is likely) and reached, say, Rs 6, the range would be 80 to 82.
Of course, trying to figure out where the rupee will go is a foolishness, best suited to deep discussions after several whiskies. What is more important is to determine how you should manage your risk. The key point to note is that the forward premiums have come down sharply over the past six months and are today just about Rs 2 for 12 months. Clearly, the standard approach of hedging a significant part of exports forward has become a non-starter, particularly as it is more than possible that the rupee has reached-or is close to-a bottom.
Also read: Look before you leap
To put some analytics behind the decision-making, the worst average 12-month decline (over the period) was 9.55, while the best 12-month rupee appreciation was 4.75. Thus, in the best case, an exporter who hedged to 12 months would gain 6.75 (the Rs 2 premium plus the rupee appreciation it was protected against); in the worst case, it would lose 7.55 (foregone depreciation minus the premium earned). This suggests a maximum export hedge of about 40% (not too far from the 50% that several companies’ policies look for).
For imports, the ratio would be reversed and static analytics suggest a maximum hedge of 60%. This is far higher than most companies are accustomed to hedging, and, if I am correct and the rupee shows signs of steadying (or even strengthening), importers will be very reluctant to hedge anywhere near this much.
Of course, these are merely starting guideposts. As volatility is expected to remain, hedging should be dynamic in terms of tenor of risk identification or percentage of exposures managed (either or both of which should be revisited every quarter, or certainly every six months); minimum and maximum hedge ratios); and, of course, the use of options.