‘RBI’s concern about speculation is misplaced’

With the rupee in a free fall, threatening to breach the 64 mark, most companies with external obligations must be busy re-working their strategies to manage risk. ButJamal Mecklai, CEO, Mecklai Financial, believes that companies need to have their risk management strategy in place right from the outset. Such companies would have no difficulty navigating through this crisis.

Excerpts from the interview:

What is your outlook for the rupee? What are you advising your clients now?

The rupee is under a lot of pressure and it is hard to see it go anywhere but down, unless there are some structural changes. It is, however, hard to give a target because we are in new territory.

Even if all the efforts to plug the current account deficit work, they will only be palliatives and will not address the real issue. There are many structural changes needed such as getting the coal story figured out, getting the power plants running and so on but this is going to take time. Talking about getting more external commercial borrowings is like having a hole in your pocket and putting more money in to that.

The advice we give is always client-specific. The general advice is, if you are losing money at current levels cut your losses unless you can afford to carry more risk. In that case look for an up-tick to cover but with a disciplined stop loss.

Is banning gold imports altogether a good idea to check the rupee?

This can lead to increase in smuggling. You cannot tell people ‘don’t do this’ and ‘do that’. People in India like to buy gold and they will continue to buy gold.

One idea I have is that the regulators should contact the Tirupati Trust because they have a significant amount of gold which is never going to be available for circulation. If they deposit all the gold they hold with the SBI, it can help them earn some money. SBI can hold part of the gold and sell the balance in the market, with the RBI’s permission. This will make 100 to 200 tonnes of gold enter the circulation, bringing down imports. The impact of this will be positive on sentiment, this will also help gold prices correct and the rupee can strengthen as the pressure on it eases.

This gold in the temples is sitting there, staring at you. Instead of using that, they are hiking the customs duty on gold, which in my opinion is completely nuts.

Why is the RBI so worried about speculation in rupee? How large a role does speculation play in driving up rupee rates?

What speculation does is to push prices that are already moving in a particular direction, further. Money is conservative and does not take risks. So speculators come in only when it’s very clear that prices are going in a particular direction and then jump in.

Speculation will not create a trend but will only make an existing trend a little worse, not substantially worse.

I completely disagree with the idea that we need to curb speculation to solve our problems. If you have made a mess, speculators will make your life more miserable. I think the RBI’s concern about speculation is misplaced.

Do you think the logic of sucking out liquidity from the system to curb speculation in rupee is a sound one?

If you suck out the liquidity, there will be no speculation. So right now there is no speculation. But the point is can you live without air? The economy cannot continue like this.

At some point you have to reverse these measures. The fact that the regulators have squeezed liquidity so hard gives speculators confidence that the rupee will move down further.

What is the connection between the inter-bank market, exchange traded currency derivatives and the non-deliverable forward market for rupee?

There is some transmission between the three. But the domestic market is the largest. So I was a little surprised when the rupee actually strengthened by one and half rupees on the OTC (inter-bank market) after they clamped down on the exchange traded futures market, so obviously there were people who were using the two markets and playing on the arbitrage.

The exchange traded futures market is almost closed down now. But this action has not really achieved anything. The rupee is still under pressure.

And do banks play a part in the speculation in rupee?

Speculation is not a bad thing and of course banks should speculate. What is wrong with that? It is a business decision. It is not the RBI’s job to worry about that.

Despite the RBI repeatedly talking about volatility being the new normal, companies are not really taking enough hedges on their external position. How can this be addressed?

We find that companies are beginning to hedge because they have burnt their fingers badly. They are still learning. You cannot sit uncovered and then cry.

The RBI also needs to get its act right. One of the positive outcomes of speculation is that it creates liquidity that reduces hedging cost. If speculation is curbed, it affects hedgers adversely. The RBI also needs to make available instruments for companies to hedge. Some good hedging instruments cannot be used by small companies. For instance only companies with networth above Rs 200 crore can use call spreads.

A client of ours, who is a large infrastructure company, has each of its projects in an SPV (special purpose vehicle). Since each SPV did not meet the Rs 200 crore criteria, they could not use this instrument.

We are also working to improve the interface between companies and banks and are trying to address the issue of how large companies pay almost nothing while small companies pay large sums for hedging. That is another area that can be improved upon, with technology and so on.

Do smaller companies use the exchange traded derivative market for hedging?

It is not that easy to trade in exchange traded futures. The reality is that smaller companies cannot use this segment because the transactions are settled in cash and are not delivery-based. The companies have to go back to the bank to buy or sell dollars. And small companies generally do not understand hedging. The really teeny-tiny companies do their transactions in cash.

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