The rupee has fallen so far so fast that not even technical analysts can divine the currency’s future.

Updated: Friday August 30, 2013 MYT 9:08:16 AM

The rupee has fallen so far so fast

MUMBAI/HONG KONG: The rupee has fallen so far so fast that not even technical analysts can divine the currency’s future. The chartists, as these analysts are also known, are struggling to make sense of a currency that is now firmly in territory that is uncharted. Strategists said that technical factors did not count for much in crisis situations in which investors were fleeing markets and the fact that the rupee was at record low levels compounded the problem because making comparisons with past price patterns was impossible. The rupee has consistently fallen below all reasonable technical targets since breaking its then record low of 57.32 to the dollar on June 10. The rupee is now at 66.55 and heading towards 70.00.“Some say the next would be 70, while others say 75. But I don’t see any specific target. It is almost impossible to set a technical target as the rupee hits all-time lows every day,” said a non-deliverable forward (NDF) trader at a European bank in Singapore.

Saktiandi Supaat, head of FX research at Maybank in Singapore agreed.

“It looks like the rupee is in a new uncharted territory. A next key level is 70.00, but the 70.00 is just a psychological level (not a technical one).”

With technical analysis not offering much guidance, investors are looking even more closely at forwards and futures markets, which can be an excellent gauge of price expectations.

These markets suggest the rupee – despite being down 18 percent against the dollar this year and recently hitting a record low of 68.85 – could fall further yet.

There are both onshore forwards and futures markets and offshore NDF markets for the rupee, with trade in the latter taking place in Singapore, Hong Kong, New York and London, unfettered by Indian central bank regulations that control the onshore market.

Rates in the onshore futures market have the rupee at 67.06 in one-month, versus a spot rate of 66.55. Three-month rates are quoted at 68.40, six-month at 69.24 and 12-month at 70.80.

Quotes in the offshore NDF market are also bearish. One-month rupee NDFs are trading at 67.49, while the three-month is at 68.74, the six-month at 70.05 and the 12-month at 72.34.

The difference between the onshore and offshore quotes reflects the different players that are active in each market. While traditionally the NDF market has been the home of offshore speculators – and still is given the pressure the rupee is under – it is also home to genuine hedging now that so many restrictions have been imposed onshore.

Indian regulators have taken steps to reduce arbitrage opportunities between the onshore and offshore markets because they believe that speculation in these markets puts pressure on the spot rate.

The NDF market has influenced India’s foreign exchange market but more so has influenced volatility, outgoing Reserve Bank of India governor Duvvuri Subbarao said after his monetary policy review on July 30. “It will be a better world for us if there is no NDF market, but we cannot wish it away.”

Onshore spot traders in Mumbai agree, saying that the severe bearish bets against the rupee in the offshore markets had a negative impact on the rupee’s opening trades on days when other Asian currencies were relatively stable.

“We are seeing the NDF markets having a big impact on the rupee’s fortunes during the current bout of depreciation. It is complicating the RBI’s rupee defence as it does not have any regulatory purview over the market,” said Subramanian Sharma, director at Greenback Forex.

The RBI has tried to make speculating on the rupee expensive. Among a wide range of measures the most acute has been to raise short-term interest rates, which have spiked by almost 300 basis points, roiling bond markets and raising the cost of funds for banks and companies looking to short the rupee – as well as inducing a rupee credit squeeze.

These measures have certainly reduced currency futures volumes, which traders estimate have plummeted to an average $2-$3 billion a day from as much as $7 billion before the measures were put in place.

What they have not done, however, is stop the rupee falling.

“Frankly, you can throw a dart on where dollar/rupee is going to be next. Unless there is a clear resolve from the authorities on the currency front, there is potential for more downside,” said a trader.

While the forwards and futures markets offer some bearish views, their quotes are positively sober compared to some of the bets being laid in offshore foreign exchange options markets.

A currency trader at a European bank in Hong Kong said many dollar options against the rupee had been bought around the 80 level with implied volatility on rupee options above 20 percent for the first time in almost a decade. Wide volatility bands are closely associated with depreciation.

India’s twin fiscal and current account deficits are putting the rupee under pressure, problems that have been exacerbated by expectations that the U.S. Federal Reserve will begin reducing its monetary stimulus measures soon, prompting many investors to withdraw from emerging markets.

While some analysts think the rupee’s depreciation is overdone, the currency market is not the only market where investors are laying negative bets against the country’s fortunes. They are also doing so in the credit markets.

Net notional volumes in State Bank of India credit default swaps, which investors use as a proxy for the Indian sovereign, have jumped by a fifth since the start of the year to $850 million, according to DTCC data on Thomson Reuters CreditViews.

The spread on the five-year CDS contract, meanwhile, has blown out to 355 basis points since mid-May.- Reuters

Rupee’s Swoon Dizzies Indians

For most of 2013, the Indian rupee, like the currencies of almost all emerging economies, has been steadily losing ground against the dollar. Over the last week, though, this drift has become a disturbance as the rupee has gone into free fall, repeatedly plumbing new lows and sending stock markets into a panic. The rupee fell by more than 2 percent against the dollar on both Tuesday and Wednesday this week, each time the biggest single-day declines in its value for more than two decades.

The rupee has been hard hit by a combination of adverse global and domestic triggers, including India’s economic slowdown (growth is down to 5 percent annually), an unsustainable current account deficit, high inflation and the flow of capital away from emerging markets after the announcements from the U.S. Federal Reserve in June that it was tapering its quantitative easing program. At beginning of the year, the dollar traded at 55 rupees; it was just above 60 rupees at the beginning of August. It has advanced more than 10 percent this month to just over 68 rupees, and no one believes the end is in sight.

These events bring back memories of India’s balance-of-payments crisis of 1991, the last time the rupee fell this steeply against the dollar, and suggest that hard times may be around the corner. Although India’s foreign-exchange reserves are far more secure now, the rupee’s infirmity has hogged headlines all month, spooking stock markets, derailing confidence in India’s growth story, prompting the central bank to take a series of short-term measures to shore up the currency and sucking the government into a series of counter-productive measures to control capital flight.

Many middle-class Indians are enraged because they view the rupee’s decline as a consequence of long-term economic mismanagement and political populism by the ruling center-left UPA coalition government, which has been in power since 2004. The prevailing consensus is that the UPA has privileged expensive social security measures with a populist tinge — the latest being a Food Security Bill that allocates, less than a year before the next general election, $20 billion to subsidized food for the poor — without taking care of infrastructure needs and the business environment. With the drying up of economic growth, large welfare programs look unsustainable.

Long part of the subterranean world of the Indian financial system — a force, like gravity, acknowledged but indistinctly registered — the dollar has suddenly jumped into prominence over the last month, a sign of how, in just a couple of decades, India has evolved away from a closed economy and a miniscule diaspora.

Some individuals and sectors have registered windfall gains from the dollar’s rise — such as the families of those nonresident Indians remitting money from the U.S., Europe and the Gulf, or the hotel and tourism business. Meanwhile, many middle-class families have had to put off plans for foreign holidays or education abroad, while also asking themselves if they should hedge against future depreciation by buying dollars now. And Indian manufacturing has been hard-hit by the rise in prices of raw materials and components. Most damagingly, the rising dollar is sure to have a knock-on effect on the economy as a whole because it will increase the cost of oil, the largest expense on India’s import bill, and further raise inflation and worsen India’s current account deficit. This prospect in itself would seem to be an adequate answer to Paul Krugman’s question in a blog post on the New York Times website last week:

OK, the plunging rupee is the big economics story of the day, and I’m trying to get up to speed on the issues. My immediate question, however, is why the panic?

Where several Indian economists have been in implicit agreement with Krugman, though, is in urging the government not to privilege short-term measures to “defend the rupee” at the cost of more urgent fixes for the structural deficiencies in the economy. A lucid instance of this argument was provided by the popular economics columnist Swaminathan S. Aiyar in “India’s Problem Is Exports, Not The Rupee.” Aiyar argued that a depreciating rupee should make Indian exports much more competitive globally, but India’s moribund manufacturing sector doesn’t have the resources to exploit this opportunity. He observed:

A falling rupee is a political, not an economic disaster. The plunge raises import prices and exacerbates inflation in the run-up to the next general election, just eight months away. …

The danger now is that dysfunction in the Indian economy will strangle any incipient export boom at birth. GDP growth slowed to 5 percent last year, after racing along at 8.5 percent for a decade. Industry and, until the recent uptick, exports have stagnated. Inflation has soared. The current account deficit is almost double what the Reserve Bank says is sustainable. …

[India’s Finance Minister] Chidambaram doesn’t have enough weapons to prop up the exchange rate. Rather, he should concentrate on converting cleared projects into actual physical investment and on converting the cheaper rupee into an export boom. If investment and exports begin to surge again, business confidence will return. That’s when the rupee will strengthen.

Aiyar was echoed in the Hindu by Raghuvir Srinivasan, who wrote:

The root cause for the problems with the rupee and the current account deficit (CAD) are not so much to do with monetary policy as with prolonged neglect of the real sector of the economy. The truth is the UPA II government has failed to create a conducive environment for investment in manufacturing. Even as inflation was raging all the action to control it was on the demand side and not on the supply side, where the problems were.

Chidambaram announced a series of measures this week to get the economy back on track, even as a cabinet committee on investment gave the go-ahead to 36 major infrastructure projects cumulatively worth $28 billion in a bid to restore investor confidence. But it’s clear there’s more pain for the rupee in the short term, with many analysts predicting a new equilibrium point above 70 rupees to the dollar — a prospect that’s now just around the corner.

(Chandrahas Choudhury, a novelist, is the New Delhi correspondent for World View. Follow him on Twitter.)

To contact the author of this blog post: Chandrahas Choudhury at Chandrahas.choudhury@gmail.com