Has rupee turned the corner?

In financial markets, we say that the ‘trend is the friend till it bends’. With this rule in mind, what can you infer from the Indian rupee’s recent performance in the foreign exchange markets? Has the rupee turned the corner against the dollar?

As is well known, after sinking to an all-time low of 68.80 against the US unit late in August (August 28), the rupee has since moved up quite smartly to the 61/62 levels. The rapidity of the move has been such that many might have missed the “bending” trend.

As the graph shows, there is a distinct “bend” in the trend at point A (August 28, 2013).

Or has the trend bent at all at point A? And, is it only a false recovery signal at A?

That is the key question before lots of Indian companies with foreign exchange exposures — importers and exporters. Importers would prefer that the weakening trend (of the past couple of years) in the rupee bent convincingly at A. Exporters would prefer that the bend, which we have seen recently, is only a false signal.

Prediction or forecast?

Making predictions, especially of the future, is a hazardous exercise. And, if the developments in the rupee market of the past couple of years — and the accompanying fundamentals/overall market environment — are any indication, it is more so in the case of the Indian rupee.

Actually, we will go by the fine distinction which Wikipedia makes between prediction and forecast. Prediction is a statement about a particular outcome; but forecast may cover a range of outcomes, it says.

Given the overall environment, we can only make a forecast about the rupee. Accordingly, one can think of a range in which the rupee can move in the next several months. In other words, we can say that the trend in the rupee may or may not have bent.

Companies, of course, may not find that helpful at all. They want precise, point predictions. Unfortunately, the market may not provide them that luxury.

For the record, currency options market quotations currently indicate that the rupee — with the spot rate currently being 61.50 — can potentially move in the range of 49 to 75 in the next one year.

Does that range seem too wide and unrealistic?

If so, doubters have to just note that:

Between June 2011 and June 2012, the rupee fell some 25 per cent;

Between May 2013 and August 2013, the rupee again fell nearly 25 per cent;

In the last two months, it is up 10 per cent from its August 28 low.

In other words, we have seen big moves both over very short periods of time (two months) and over longer periods of time (one year) — in both directions .

With that backdrop, a 49-75 range over a one-year horizon appears quite realistic.

Fundamentals and markets

The options market quotation is like an index number. It summarises the impact of many different fundamental factors/market situations and how they evolve on an on-going basis.

For instance, a key market change of the past couple of months — with the rupee going up to 61 from 68 — is:

That India’s oil companies are not buying dollars directly in the market for their imports;

The RBI is loaning them the dollars required;

The US Federal Reserve has postponed its QE tapering (probably well into 2014).

Since the oil demand — nearly $800 million per day (going by last year’s POL bill) — is not directly hitting the market, market dollar demand is lower now. That has helped the rupee.

The Fed’s QE postponement has added to the rupee recovery by calming the nerves of overseas investors in emerging markets.

That is the immediate story.

But, note that the oil companies have to repay the RBI in course of time.

The loans are just trade credits provided by the RBI to the oil companies. (This is a stretched exercise of the RBI’s powers — much like the Fed’s use of its powers to lend to AIG/help JP Morgan’s purchase of Bear Stearns some five years ago.)

At $800 million per day, that is a sizeable $30-billion repayment (for loans between August 28 and now) coming up.

The oil companies have to find those dollars in the market. And, it is very obvious that they are not hedging those requirements — for, if they do so, that would straightaway nullify the effect on the rupee’s exchange rate of the RBI’s loans in the first place. (Roll-over of the maturing loans is possible; but, that is just kicking the can down the road).

Once the RBI’s loan window is closed — if it is closed — the oil companies have to also fund their on-going imports.

So, the fundamentals picture is not that great for the rupee, unless there is a sharp reduction in oil demand (and overall import demand); and exports pick up very strongly. The current trends do not indicate any sharp slide in overall import demand. As for exports, one has to wait and see.

Against that is the fact that the Fed could well stand pat at least for the next six months.

Also, introduce domestic political uncertainties into this fundamentals/market mix and factor in the dollar’s global performance.

Overall, what the options market indicates as the one-year (95 per cent) probable range for the rupee therefore seems very reasonable. The near term — say up to three months — will be just a microcosm of the one-year range as it evolves.

As for companies, no choice but to deal in these volatile markets —– by employing appropriate risk management products.

(The author is a Chennai-based financial consultant.)

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