By Jamal Mecklai
The rupee’s sudden, sharp (nearly 1%, to 89.49) fall on Friday afternoon caught most people off guard. Over the preceding few days, the rupee had steadied from its lows of 88.70 and even hit a peak of 88.50—although, to be fair, that’s hardly a huge appreciation—on Wednesday. This is despite the atrocious trade figures reported for October (deficit at an all-time high of $41.68 billion, with exports falling by 11.8%), which came on the heels of a large deficit in September ($32.15 billion, which was driven largely by the goods and services tax cut-driven boom in purchases for Diwali). People were beginning to believe that a trade deal with the US was not far off—indeed, Reserve Bank of India (RBI) Governor Sanjay Malhotra mentioned as much.
The cause widely ascribed to the rupee’s fall was an ebbing of this belief, although it is hard to see how something that touchy-feely could result in such a sharp drop. More likely the dramatic increase in Japanese bond yields—the 30-year crossed 3% and the 10-year nearly reached 2% from just 1% a year ago—triggered an unwinding of carry trades (where people borrowed in yen and invested in other higher-yielding currencies), which in turn triggered the sharp selling of rupees in the non-deliverable forward (NDF) market. Buyers’ stop losses, which were amassed at 88.80, were triggered, which led to the mayhem.
Other factors
While the steadily increasing volumes in the offshore market do provide some credence to this view, it is offset to some extent by the fact that none of the other Asian currencies, which would have been part of the carry trade against the yen, fell that day. Nonetheless, the lesson is that the NDF market has become increasingly important to India and to understanding the trajectory of the rupee.
Indeed, back in October when the rupee was sagging, at least partly because of the reduced supply of dollars as a result of the large trade deficit, the RBI intervened by selling dollars in the NDF, chasing it down from 88.8050 on November 14 to below 88 (a low of 87.73) on November 17. I was particularly chuffed because a couple of weeks before that, I had written an article (High import prices are India’s Achilles heel) recommending just such an approach.
I had felt that the RBI should have continued with the pressure, taking the rupee to (at least) below 87 to try and change the mindset that the rupee will always keep falling. It was pretty apparent that high import prices were/are hurting not just the poor and the lower middle class but also making it difficult for exports in some sectors with a high import intensity; I haven’t seen any comprehensive studies, but some statistics suggest it could be as high as 30-35%. Again, it was quite obvious by then (and now) that the sharply weaker rupee was not helping exports, which are hampered much more by still-difficult process constraints than the exchange rate.
Over the past couple of months, I have spoken with several Indian businessmen about why exports have not been growing, and each one (although, of course, not for public attribution) described a litany of problems that could well have been from 10 or 15 years ago—transportation costs, customs delays, incomprehensible rules, tax harassment, corruption, agricultural inefficiencies, and so on. Not one of them spoke about the rupee.
RBI’s mandate
But the RBI identifies its own mandate as a macro one, and, to be sure, it has been doing a great job given this context. Banks are much healthier—foreign lenders are looking to get a piece of the Indian banking market; inflation and GDP growth seem to be well-balanced (I would prefer a focus on GDP per capita, although I understand that is the government’s responsibility); and financial markets appear to be in reasonable health.
I have been interacting with the RBI for over three decades and I have great admiration for all the teams I have met even over such a long period. But, and particularly because I see so much commitment and skill there, I would be happier if it could define its mandate a little differently so that its constituency is not largely entities in the financial sector, as a result of which its decision-making is focused on what it believes works for the macro-economy and its constituency—in other words, elites.
As to the rupee, since, as Governor Malhotra recently repeated, the RBI is not focused on any specific level but only tries to contain volatility. It will likely bounce back from its current all-time low, particularly as many savvy exporters have seen a pattern where the rupee falls sharply and then steadies under the RBI’s hand and will likely sell at these hugely profitable levels.
In the medium term, however, the pressure will recur, unless, as I suggested, the RBI takes the rupee by the horns and brings it back below 87 (at least), telling the market it is still the boss.
The writer is the CEO at Mecklai Financial
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