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Lokeshwarri S.K.

BL Research Bureau One surprising sidelight to the recent market mayhem is the sharp depreciation in the rupee relative to the dollar, with the domestic currency sliding by 14 per cent in a short span of three months.

The rupee’s depreciation from Rs 39 to Rs 43 against the dollar between January and July this year was primarily instigated by the spike in crude oil prices to $147 a barrel. Crude oil prices have since cooled to around $70, but the rupee has continued to depreciate and is currently close to its all-time low.

So what’s driven the rupee’s weakness? First, is the unexpected strength in the dollar itself, against all the global currencies. Despite the mammoth proportions of the credit crisis and weak economic data emanating out of US, the dollar has continued to soar merrily against major currencies in recent months.

The US Dollar Index, a measure of the value of the dollar relative to a basket of six major currencies traded on the Intercontinental Exchange (ICE), has gained 17 per cent over the past quarter. As the US government pushed through the $700-billion bailout package, there was wide-spread expectation that this index would weaken, but it strengthened further instead.

The reasons for the strength of the US dollar are not hard to seek. Fund-flow data released by Emerging Portfolio Fund Research (EPFR) for the third quarter of 2008 reveals that US equity funds witnessed an inflow of $42 billion in the third quarter of 2008, US Money Market funds attracted close to $40 billion and US bond funds attracted $8.9 billion in the same period.

“During the past quarter, we’ve seen a marked shift away from the pattern of the past three years, as investors have moved out of emerging market and global equity and bond funds and back into US equity and bond funds. That could have been driven by several factors, including a classic flight to so-called safety, expectations of dollar strength, and investors using Exchange Traded Funds (ETFs) to short the market,” noted EPFR Global Managing Director, Mr Brad Durham.

What is more, this ‘flight to safety’ has caused a global shortage of dollars. “The liquidity squeeze in dollars made the US dollar index gain while commodities declined over 40 per cent in the same period,” adds Mr J. Moses Harding, Head (Global Markets Group), IndusInd Bank.

Finally, the rupee futures traded in the off-shore Non-Deliverable Forward (NDF) market have also influenced the domestic exchange rate. “The NDF market, being a non-regulated market, normally throws up arbitrage opportunities for foreign banks with branches in India. There is usually a difference of 25 points between the NDF and the Over the Counter forwards traded in India.

“In the current credit scenario, the difference has widened to as much as 70-90 points on some days. The arbitrage presents a good profit opportunity for the banks and this in turn impacts on the rupee,” says Mr Dilip Raghuwanshi, Advisor Forex, Asit C Mehta Forex Pvt Ltd.

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