Now that the rupee has broken smartly above 69 to the $, the level at which Raghuram Rajan came in as Governor (2013) and which had provided a strong support to the rupee till last August, when it fell sharply (to nearly `75 to the $) during the last rupee ‘crisis’, where do we go from here?
Will this episode parallel what happened in 2009, when, after hitting a (then) all-time low of `51.95 to the $, the rupee strengthened by nearly 15% over the next 2+ years? Or, will it simply rally for a year as it did in 2012-13, before falling sharply again (to another all-time low)? Or will it hold above the current all-time low (of `75 to the $) but be battered with high volatility for the next 5 years, paralleling its path from 2013 to 2018?
Or, since history only repeats itself approximately, will it trace an entirely different path?
There are no answers but it may be worth looking at several new forces in the game. Perhaps the most significant is the possibility that India’s share in the MSCI index may be increased—this would substantially influence debt flows into the Indian market—indeed, on March 14, there were debt inflows of $223 million, more than double the average daily debt inflows earlier in March.
Then, there is the $5 billion debt swap, where RBI will buy dollars and sell rupees to banks. While this is intended to improve rupee liquidity in the market, it has had the immediate effect of depressing the forward premiums, which could be an effective way of forcing medium-term rupee rates down, which again would draw money into the debt market to benefit from falling yields. As far as FX goes, the swap should have the impact of taking dollar supply out of the market—in other words, increasing relative demand for dollars, which is the reverse of what has been happening. Of course, it could be that banks are borrowing dollars overseas to swap them into cheap rupees for domestic operations—this, then, would be neutral for spot USD to the INR. The swap goes to auction on March 26, so we will likely see increased volatility right about then.
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And, of course, there is the belief that, since the Pulwama attack, Modi’s chances for returning as prime minister have increased, which is drawing foreign investors into Indian equities, strengthening the rupee. To be sure, since February 22 (the date of the response), equity inflows have strengthened. There is certainly some talk in the international press about this, and, of course, some pretty hysterical rhetoric from the ruling party—and, to be fair, from the Opposition as well. The truth on the ground, however, is much more complex, and, as we know, the ‘Great Indian Election’ show always surprises. I wouldn’t take any bets.
In any case, hedging FX risk should not be about taking bets. After every sharp decline, there is a reaction; and, after the reaction runs its course (over varying periods), the rupee continues back down—usually below the previous all-time low but at very least back to that level. It is hard to see the broad pattern change.
With volatility high, it is dangerous to stay overly exposed. Importers should celebrate the much lower premiums and increase their hedges; exporters should note the still-high volatility and shorten their hedge horizons.
And we all should vote for a brave, new India that builds on the strengths of all our people. Jai Hind
The author is CEO of Mecklai Financial