Rupee has almost met the first downside objective set at 55.25 (low of 55.08) ahead of short term objective at 56.75-57.00, which is expected to complete the end-to-end of set short term range of 52-57; since then (set up of this short term range) rupee is down from low of 52.01 (seen on 23rd April), covering 60% of the journey in one months' time. Rupee is down by over 25% since July 2011 low of 43.85 and by over 13% from the February 2012 low of 48.60 (at annualised rate of over 52%). This sharp rupee depreciation is a serious concern for stake holders who have large uncovered dollar liabilities and sold most of export realisation. It is worse for those who have bought interest cost reduction derivative structures by shift of rupee liability to foreign currency, mostly to USD and JPY. It is a big worry for RBI as this sharp depreciation in rupee has knocked out the benefit of over 14% in BRENT Crude, down from high of 128.40 since 1st March 2012. The expectation of shift into pro-growth monetary stance, on the back of accelerated rupee weakness beyond downtrend in crude oil price is not relevant now. RBI will continue to see inflation as major risk to growth.
RBI has done all it could to arrest rupee depreciation with no tangible impact; it could only delay the inevitable but could not deny it! The recent measure to cut the "arbitrage flows" between OTC spot market and ETF forward market is a major one. The integration between these two markets generates liquidity to cut the "lead and lag" play and enable efficient price discovery. It is a major decision to cut the integration between cash and futures market. Why this tough decision? The forward value of the dollar in OTC market is not a reflection of future expectation of spot value. It only captures the interest differential between the two currencies which are exchanged from start to end date. On the other hand, forward value in the ETF market builds in expectation of the future value; thus generating lead and lag play between the values in OTC and ETF market. How it impacts? When the going is tough for rupee, forward dollar in ETF is costlier than OTC market which generates dollar demand in the OTC market which flows into ETF market to cut the arbitrage. When the going is good for rupee, forward value in ETF is cheaper than OTC market which generates dollar demand in the ETF market which flows into the OTC market. What is the end result? When RBI comes to protect rupee (by sale of dollars), there is pent up demand for dollars in the OTC market and when RBI tries to arrest excessive rupee appreciation (by buying dollars), there is flush of dollar supplies in the OTC market. In either of the case, it makes life tough for RBI (by making intervention ineffective) and not seen as good for the economy and its stake holders. Unfortunately, even this measure could not provide decent "correction"; knee-jerk reaction held well at 54.60 and up sharply to post new intra-day low of 55.08 and but for RBI dollar sales would have taken out 55.25.
The market is closely watching next steps of RBI; mopping up of $10-20 billion of "India Resurrection Bond" issuance from NRIs (and other non-resident investors) may not help to guide rupee reversal beyond 53.50. The need is to address issues related to capital account flows and issues are complex with mix of woes from political, economic and monetary regimes. RBI is very vocal about the need of capital flows to bridge widening current account deficit. The threat is also that of India exit from BRICS group and moving out of the radar of foreign investors. The issue on hand is serious and no serious attempts are being made by the Government to provide course correction.
What next? The near term range now stands shifted to 54-57 with strong protection at 53.50. It is matter of time for 55.25 to give way on USD Index back into recent high of 81.75 (with EUR/USD holing below 1.29 for 1.26). It is also matter of time for NIFTY to extend its losses into 4500. These strong market forces (acting against rupee) will make it tough for RBI to defend extended rupee weakness into 56.50-57.00. We have completed 60% of the journey (from 52 to 57) in one month time and may not rule out faster pace for the remaining 40% of the journey towards 57.
The author is Head – ALCO and Economic & Market Research IndusInd Bank, Mumbai
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