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The Great Fall
The Indian rupee is one of the worst performing currencies in the world during 2013. At Rs.65/$, it has slid by a big 17.5 per cent so far.

THE CURRENT RUPEE level is the highest ever seen. From a low of Rs.39/dollar in Feb 2008 the fall to Rs 65/dollar in 5 years is some fall indeed! Repeated efforts by the RBI to stem the rot have gone in vain so far. The trigger for such a dramatic fall has been attributed to the US decision to roll back Quantitative Easing (QE) as the US economy has started showing signs of a pickup.  The following questions emerge out of this:

•    Why did the rupee depreciate so fast?

•    What is the further downside and where can it settle?

Let me try and answer each of these and close out with a possible strategy. Predictions can be hazardous; strategies need not be!

Why did the rupee depreciate so fast?

Technically the rupee depreciates against the dollar when people sell rupees and buy dollars. When this happens, it results in negative capital flows leading to downward pressure on the currency. The following reasons can be explored:

•    US monetary policy

•    Slowing Indian economy

•    Ineffective RBI

•    Corporate debt and hedge

•    Weak domestic equity market


US monetary policy

The US Fed initiated a series of monetary easing programmes, commonly known as Quantitative Easing (QE), which created huge liquidity in the global market. The simple idea behind QE is to buy government bonds in order to keep the yields low, as low interest rate will help the economy recover. Now that the US economy is showing signs of recovery, the Fed has announced its intention to taper the QE. In response to this news, bond yields started moving up and capital has started moving back to US in search of safety. In short, capital left markets like India and has headed back to the US.

Result: Investors flee other currencies and take shelter in US Treasuries causing USD to strengthen and other currencies to weaken.


Slowing Indian economy

The Indian economy has lost its sheen and grew at just 5  per cent in 2012-13. The Indian economy’s deficit is spiraling out of control. Both the fiscal and the current account deficit are headed for further deterioration during 2013. While the fiscal deficit is at 4.9 per cent of GDP, the current account deficit is at 4.8 per cent in 2012-13. The CAD is triggered primarily by trade deficit. Not only our imports exceed exports but also within imports the dominance is by oil and gold imports, something very difficult to control. Lack of progress in deficit reduction is causing poor foreign investor confidence, which contributes to foreigners taking their money out of India. The deficit is a long-term problem, especially the fiscal deficit. No matter which government is in place, populist policies will continue and this will ensure that the deficit does not come down. However, if they do not go up, then that itself will be good news.

Also, during the past few years, Indian government has attained notoriety for governance lapses (2G scam) and policy missteps. Revising the Income Tax Act retrospectively from 1962 in order to bring Vodafone to book was a huge blow to global confidence in our legal structure to foreign investors. Also, there were several governance failures that keep India on the wrong side of the news globally (a good indication is the number of negative articles that appear in The Economist).

Result: Foreign investors exit by selling rupees and buying dollars


Ineffective RBI

The Reserve Bank of India is tasked with ensuring the financial stability of the economy and hence is the sole administrator of monetary policy. In the past, when currency encountered volatility, the RBI used its foreign exchange reserves to intervene in the market (through purchase or sale of dollars) and thereby reduce the volatility of the currency. However, this time around, they openly declared that they weren’t going to intervene. This may be due to limited foreign exchange reserves; currently at $277 billion, enough to cover only 7 months of imports. For China, it amounted to 21 months of import cover, a comfortable situation to be in.

Instead, during the July and early August meetings, the RBI intervened by tightening the monetary policy. It increased short-term rates by hiking the marginal standing facility by 200 basis points. This further exacerbated the situation. During its latest meeting, it signalled a reversal of this tightening of policy. Hence, we can clearly understand the predicament of RBI to intervene. While RBI has not interfered directly, it has taken several steps to contain the situation:

•    It now requires exporters to repatriate 50 per cent of export earnings placed in special accounts

•    Restrictions on investments abroad by Indian companies and citizens.

•    Limits on intraday net open positions of foreign exchange dealers

•    Restricting currency derivatives

•    Hiking the interest rate on NRI foreign currency deposits as also rupee deposits

Result: RBI has no arsenal to arrest the slide immediately but is using other indirect means.


Corporate hedge and debt

Treasury managers relaxed when the rupee strengthened during 2010, averaging 45 (you don’t need to hedge when rupee is strengthening if you are an importer and vice-versa). They expected this to continue forever and hence did not bother to hedge their currency risk exposures. Also, many of them resorted to foreign currency borrowing in short-term maturities disregarding the rupee depreciation danger. When the rupee started its free fall they were caught off guard and ran to hedge their exposure, which led to intense buying of dollars leading to its appreciation. Now, many short-term corporate debts are coming up for repayment, which will also witness more dollar buying adding to the rupee pressure. Also, the ability to rollover the debt will be limited by European banks due to the European crisis.

Result: Companies will have to find dollars to repay their debt and incur loss due to un-hedged positions.


Weak domestic capital market

The Indian equity market has not been able to attract investments from Foreign Institutional Investors (FIIs) due to the weak economy and the poor performance by Indian corporates. Although the equity market has seen FII inflow of around $12 billion till August 2013, it has witnessed net FII outflow of $3.1 billion from June till August 2013, which has exacerbated the fall in the value of the rupee. If you look at Table 2 the outflow seems to be more on debt than on equity. If this trend continues, it will result in further depreciation of the rupee.

Result: FIIs will continue to shun Indian equity unless the economic conditions become more favourable.


What is the further downside?

The global financial crisis has accentuated the problem.. This has caused many currencies to fall (Table). RBI is playing a sensible role of not exhausting our forex reserves and is allowing the market to determine the level of rupee.

    If required, it could call on SBI to raise external financing from NRIs like how it did in 1998 and 2000 (remember the millennium bonds?). However, the days of Rs.50-55 are gone. Political weakness is expected to continue with weak policy responses on all issues especially with the elections round the corner. In terms of where they will settle, rupee is a moving target and hence it cannot settle anywhere. In terms of calls, investment banks place at from a pessimistic Rs. 70 to an optimistic Rs. 60 in the next 6-12 months.


What is the long-term outlook for the Rupee?

The current rupee bash has raised some structural questions about its long-term potential. Any call on the rupee is a function of the long-term performance of the economy. India, along with China, is among the fastest growing economies even after taking the current dip in growth. Given the right leadership and reforms, the economic potential of India appears good. India does not have any sovereign borrowings in foreign currency. Hence, the current abyss can be reversed with some wise leadership and policy reforms. With respect to global crisis, it cannot be predicted as to when and where it can arise. There are several pressure points in the world and anything can erupt anytime to cause tremors in emerging markets like India. Only sound monetary and fiscal policy can save the day for India.


What should be the strategy?

Currency and interest rates are the hardest thing to estimate in financial markets. Hence, the best thing would be to hedge and not try and anticipate currency movements. Having said that, the following could be done:

If you are a domestic investor, focus on export-oriented sectors like IT for investments. They will have a great year ahead. If you are a non-resident Indian, this is the best time to remit money to India. If you have dollar investments, it will be wise to exit the position and remit the money back to India. If you have rupee denominated debt, partly wind it down using remittance from abroad. If you are a corporate in India with significant

foreign exchange exposure (either as importer or exporter), have some sound hedge in place as currency volatility is only expected to increase than decrease.



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