Underlying Trends in the Rupee market
Last Updated: 20th Nov 2000
We all know that the Rupee has depreciated by 7.8% from 43.50 in January 2000 to 46.90 in October 2000, in keeping with the 6-7% annual depreciation that the Rupee is commonly expected to undergo. There are now varying opinions whether there will be further depreciation in this fiscal or not.
Without going into question of which direction the Rupee is likely to take hereon, let us take a look at some of the underlying trends that make up the very structure of the Rupee market. Let us examine the trends in Balance of Trade and in Foreign Equity Inflows. Let us also look at the notion of "Market Stability" and the issues relating to Market turnover, depth and development.
Resilience on the Trade Front?
Based on the RBI Monthly figures that are available till August, it would seem that India's Balance of Trade is developing a greater resilience than before. The BOT Deficit grew by only 4.8% to $9.6 bln in 1999-00 over the $9.2 bln of 1998-99. And if our projections be correct, the deficit may grow by only 4% or so in 2000-01 to about $10 bln. The natural question is, "How is it that despite the higher Oil imports, the Trade deficit is not ballooning?"
For one, for the first 5 months of the current fiscal, Exports, at 20.17%, have grown faster than Imports at 17.25% over the corresponding period in 1999-00. Secondly, while Oil Imports at $ 5.5 bln uptil July in the current fiscal, had doubled over the same period in 1999-00, this rise seems to have been compensated by a fall in Import demand from other sectors such as Capital Goods.
Rupee affected by FII Flows
Given the good showing on the Trade front, perhaps it is easy to understand Dr Bimal Jalan's consternation regarding the Rupee's vulnerability. The point is that the Rupee is highly correlated with FII Inflows, as is clearly illustrated in the graph alongside. The Rupee came crashing down from 44.15 in May alongwith the Sensex and FII flows, the latter falling from an inflow of $597 mio to an outflow of $258 mio in June.
This is not agreeable with the RBI, which subscribes to those outdated economic theories which admit of only Trade as the determinant of forex rate movements. This is made clear by the RBI's indigestion regarding the depreciation of the Euro and the Pound against the Dollar.
Page 2 - Underlying Trends in the Indian Rupee market
Predictability versus Stability
The RBI feels that the forex and equity markets are not predictable because they are unstable. The point is that mired in the delusion of outdated Equilibrium Economics the RBI believes that markets should be Stable. But, that is impossible, for Instability is the very nature of all markets. It does not follow, however, that instable markets are also Unpredictable. On the contrary, it is Stable markets that cannot be predicted and are hence dangerous. A deep and moving market, however, can be highly predictable using the techniques of Technical Analysis. This has been proven time and again by Traders worldwide.
For a good demonstration of the myths and misconceptions regarding Stability, Volatility, Predictability and Risk, you are invited to try your hand at a little "Risk and Predictability" game on our website
We see how the stability of the Rupee can make it a dangerous currency. Further, that the Rupee market is thin and illiquid is conceded (and lamented) by all market participants. The RBI bemoans the "herd behaviour" of the market. The obvious solution to this malaise is to increase the turnover in the market which will provide both greater depth to the market and bring in more players with opposite views.
|($ mln)||Dly Avg Real||Dly Avg Market Turnover||Coverage|
The table alongside is based on the figures in the RBI's November bulletin. The traded daily Spot demand for foreign currency in the market covers the daily average Import demand 4.62 times. Similarly the traded daily Spot supply of foreign currency in the market covers the daily average Export volume 5.34 times.
On a normal day, the supply and demand more or less match each other and we have the Rupee moving in narrow ranges. The Turnover, however, provides but a meagre coverage of both Import and Exports, incapable of absorbing sudden or sustained increase in demand (the increased demand from Oil PSUs this year, for instance) or the decrease of supply (by FIIs selling on the stock market). A lay assumption would be that the daily Turnover should provide a coverage of at least 10 times to the real demand or supply.
The Turnover can be increased by:
a) permitting Exporters to sell Foreign Exchange on the basis of their projected exports, a facility which was available earlier
b) allowing Importers to re-book and re-cancel Forward Contracts, as permitted earlier
It is a false notion that the entire market is given to "herd behaviour" and which can lead to unchecked depreciation of the Rupee. The market knows that there were enough Exporters who were ready to (and who did) sell Dollars near 45.20 and 46.20. The persistent thinness of the market, coupled with the RBI's micro-management and tinkering with the market rate is at least partly responsible for the further depreciation of the Rupee thereafter.
Market versus Rate
Among the Major currencies like the Euro, Yen, Swiss Franc and Pound, the Euro is the most liquid and, as Traders worlwide will aver, the most predictable and manageable (irrespective of and contrary to what the RBI would have us believe). On the other hand, the Pound enjoys the least liquidity of the four majors and is the most unpredictable and volatile of them all.
There is a direct relationship between the depth/ liquidity of a currency and its predictability (and hence safety) of a currency.
Thus, if the Rupee market were deepened (by allowing more players and more speculation, instead of killing it), the exchange rate could become more predictable and less dangerous. It behooves Dr Jalan to develop the Market instead of losing sleep over the Exchange RateD. What if Dr Mehta of SEBI were more bothered about the rate of Infy than about the market as a whole?
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