The Rupee Conundrum
With the kind of free fall the rupee observed in the past couple of months, almost everyone from your grandmother to the last daily need shop owner in your street have started asking, when will this slump stop, if at all.
The worries don’t stop here; even equities and debt markets have cried blood. This blood bath has turned the Dalal Street into a haunted graveyard. The plummet doesn’t seem to be ending any time soon. The government is being booed continuously and the RBI seems to be clueless. The liquidity tightening and capital control measures have gone out of the window – but before doing more harm than good.
While the rupee is incessantly falling, we are holding our heads helplessly as mute spectators witnessing the collapse of our economy every second.
Let the rupee find its fair value itself
As almost every card in the pack has been played out by the government and the RBI in arresting the rupee’s fall, it appears, the Indian currency can’t be tamed manually. It should be allow finding its fair value on its own. Its depreciation of around 16% against the greenback this year does make us realize that the rupee was highly overvalued.
Although, ever ballooning Current Account Deficit (CAD) and considerable gap in the revenue and expenditure at the domestic front do lead us to be believe (and rightly so) that our fundamentals should be worked upon, but the rupee fall is not only about deteriorating fundamentals.
Renowned economist Surjit Bhalla has opined before that even nations with current account surpluses have faced currency depreciation by roughly 25 to 30 percent on an average. In fact, it’s all about drying incoming investments and unless they are dealt with soon, and dollars pumped into our economy, the plummet of the currency won’t stop anytime soon.
Recently, a slight recovery was observed in the currency when the RBI sold some dollars to the Oil marketing Companies (OMCs) for meeting their dollar demands to pay for imports at the month’s end and injected more through the Open Market Operations (OMOs). This proves that economy is need of dollars at the earliest possible.
But for the reason markets are unknown of the fact how much of dollar reserves the RBI has in actual, rupee is not able to decide a clear bottom for itself.
Still, dollar infusion (though some may say positive words from the PM) has helped USD/INR rate to find some kind of support at 66-67 levels, correcting itself from 68-69 range last week. Unless, the Syria war begins, the rupee is expected to maintain this range for a week atleast.
Generally, experts make use of Real Effective Exchange Rate (REER) during the times when volatility is low in the market to get a real idea about the fair value of rupee. REER is defined as weighted average of a currency of one nation in comparison with others (trading partners mostly), adjusted for inflation. A currency for which the REER index is closed to 100 is termed to be valued fairly and anything above or below it is considered to be overvalued and undervalued respectively. The rupee has been undervalued since 2004 to 2004 when the currencies from six major trading partners are taken into basket.
The REER (six currencies) fell to an all time low at 93.90 in March 2009 and for the present year it stands at 96.94. This means we are still overvalued and more fall is anticipated to touch the all time low.
Therefore, the rupee will plummet more irrespective of what our government or the RBI comes up with. To stem its fall, dollars need to be brought into the economy soon.
Exports and the Rupee Fall
Usually, the rupee depreciation brings with itself competitiveness that increases scope for export for any country. This results in increase of exports and decrease in imports bringing CAD back to a sustainable level. Therefore, currency depreciation is a favored option even in good times and China is a perfect example. However, India doesn’t seem to be benefitted by this age old principle of economics. Why?
The reason for why we are not able to make much on the exports side in such a scenario because our top 5 export-petroleum exports,gems,jewelery,gems and textiles contain considerable imported inputs. And, hence any favorable effect in exchange rate doesn’t bring in any favorable effect on the export side. Also, considering the rupee fall even importers in other countries are pressurizing our exporters to re-negotiate deals at lower prices. And, lastly unlike China, our infrastructure for export is too pathetic to bring us any kind of lead in such a situation.
NDF Markets: The major worry
Lastly, RBI measures other than pumping in dollars in our dollar strapped economy won’t help much because the other major reason for our currency’s fall lies outside our country than within.
For the last few months, not only the rupee but many other currencies have taken a deep fall. And, speculation of currency is what has been termed as the major culprit for the steep fall. Since July, speculation in currency forward markets has been curbed considerably by the RBI and even banks have been prevented from taking proprietary positions in currency exchanges for themselves. They can only do such for their clients now. This reduced the tradable currency volumes by more than half in the domestic currency forward market but unfortunately the global non-deliverable forward (NDF) markets are out of regulation of the RBI. The average daily volumes are in the order of around $50 billion in NDF market in comparison to a partly $5 billion in local derivates market.
And, interestingly, both the markets are interconnected. The RBI economists claim that the NDF market influences the rupee-dollar exchange rate volatility in onshore markets. Therefore, even if our government comes up with strict capital controls (as it has lately), the movement of non- deliverable partially convertible rupee can’ be regulated at all.
As per the official records, trading of rupee in the NDF market is estimated to e around $60 to $70 billion per day in markets operating from Singapore, Hong Kong, New York and London presently.
Therefore, the speculation driven price trends there get reflected in our markets and hence difficult to regulate.
Unless, there is move towards making the rupee completely convertible (China is already working on the concept) India will also find itself troubled by violent moves in the NDF markets. Already we are completely integrated with the rest of the word in trade and financial flows and therefore, a fully convertible rupee is an idea in the right direction.
But, till then keep fingers crossed, and pray that America doesn’t go all out on Syria and cause oil and other commodity prices to increase further denting any hope of rupee’s revival.