Tuesday, May 20, 2008

Where is the Rupee headed?

Does anyone really care?

Currency markets, like their stock market cousin spring surprises when people least expect. Almost all exporters and dollar earners and spenders were caught off guard by the recent depreciation of the Rupee. While dollar earners lose the forward premium, the (oil) importers (dollar spenders) never bothered to cover their exposures. Who ever thought appreciation of the greenback?

The reasons for the sudden reversal were not far to seek.

(1) Recovery of the US dollar;
(2) Increased dollar buying by oil companies to meet rising oil import bill;
(3) Sinking capital inflows, choking the supply of dollars; and
(4) Unwinding of positions that were betting on rupee surge.

So where is Rupee headed? Surging oil import bill and expectations of moderating export growth suggest a worsening current account deficit this fiscal, likely to edge past 2% of GDP. It is said that a $10/bbl increase in crude price jacks up the trade deficit by around $6.5-7.0 billion. Higher global crude oil prices also boost remittances, but the net effect of higher oil prices on the current account deficit is still a large negative.

Back in 2002 when the first draft of Goldman Sachs BRIC report was in print, the rupee was at 49 to the dollar. The BRIC report forecast (and still does) that India would be the third-largest economy in the world by 2050 with an amazing 9% growth per year for fifty years. But something went unnoticed - it was in dollar terms. It also said in the first six years the rupee would be stronger by about 13%, which is exactly where it is today. Call it Goldman’s magic touch or just luck. For after all, the rupee didn’t get from 49 to 42 in a steady linearity. It rode up to almost Rs.38 to the $$ before getting to where it is today. So I think the flip flop will continue.

I pity all $$ borrowers that had raised ECBs and left the proceeds unhedged assuming a forever strong rupee. They should be losing some sleep now. The currency — like the broader economy — is mainly reacting to some near-term headwinds that have brought about a welcome correction in hype over the India story. India certainly has a story; at a very basic level. It could do with better education, healthcare and public infrastructure. The Rupee will find its own level depending upon how RBI is coping with its routine of non-intervention, trying to keep volatility low and creating awareness about risk and currency hedging.

Most importantly the Government has to learn to deal with political shocks – finding the Rs 60,000 crore largesse to farmers, then the Rs 25,000 cr largesse towards the government employees happiness fund. All of it will have an impact on fiscal deficit even if it keeps huge oil subsidy as an off-budget item.

So it is total chaos out there. Don’t fret over a number. Stick around and watch the fun and cash in on an opportunity as and when it shows up.

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