5 December 2005

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It is abundantly clear from the recent price action that sentiment has turned towards a weaker rupee, with the market steadily pushing the rupee lower. It appeared to hit something of a roadblock at 46 to the dollar a couple of weeks ago - call it "fear of RBI intervention" - but that, too, has fallen, with the rupee closing last week at its weakest since July 2004. Perhaps more frighteningly, the 46.50 level, which represents a major - and final? - support, is well in sight.

So, what's the prognosis?

Well, over the past two months or so, this long-term rupee bull has been slowly turning around. When the rupee fell below 44 to the dollar at the end of September, my fear was that the extremely short (almost over-short) dollar position in the market could drive the rupee rapidly towards, and perhaps through, 45. I hadn't yet shifted from my long-term view by then, but it seemed like the market was technically too short dollars and it had to "correct". By the second half of October, by which time the rupee had breezed through 45, I began to get a sense that these technical factors hadn't really been resolved - the forwards were still low, suggesting that there had not been too much import buying - and that there were other "technical factors", like the NDF arbitrage window, that was maintaining pressure on the rupee.

By this time, of course, I began to realize that maybe what was happening was a fundamental turn in sentiment. It was hard for me to throw away the "38 in 5 years" comment, on which I had been dining ever since 2002, when I first recognized that the long term downtrend in the rupee was over. And I began to start considering the possibility that maybe - just, maybe - the rupee was primed to turn downwards again.

After all, the current account had turned to deficit after 3 strong, positive years. And, while India had certainly arrived - and is certain to remain - on the global investment map, the steady rise in U.S. interest rates was beginning to bite in terms of global risk aversion. The dollar continued to surprise globally, holding at deficit-snubbing levels against the Euro and the yen, and gold and the non-ferrous markets were at multi-year or all-time highs.

On the ground, the Indian economy is on fire. And, critically, this appears to have been lit by steadily rising demand at lower and lower income levels. My driver has had a credit card for two years; most of his friends have joined the consumer bandwagon as well. And while I recognize that Mumbai is just the highest crescent of cream on India's cup of cappuccino, the fact remains that there is sufficient confidence to step into the credit markets even at relatively modest income levels, where the number multiplier is huge. When this realization came to me (about 10 days ago), I realized that 46.50 is there for the taking.

And then, last Friday, I went to Osian's art auction at the Taj. Now, I've been involved with the art world for a long time now, my wife has an art gallery, I have written about art and the art market, I have a "feel" for what's going on. Or so I thought. The auction was a knock-out. To quote another art aficionado, she was "shell-shocked". It was not just that prices were soaring to stratospheric levels - 2.7crore for a Tyeb Mehta, 1.7 for a Husain, 84 lakh for a Ramkumar, 70 lakh for Swaminathan - but the matter-of-factness with which people ramped prices higher in 1 lakh bites. And these were not any high-profile celebrity buyers. They were rich, of course, but the point was that the number of seriously rich people - rich enough to start bidding at 4 lakh and run it up to 12, for instance - is huge. Granted that the art market has got a lot of press recently and some of these may have been buying for "investment". But the fact remains that India - at all levels - has an unprecedented amount of money to spend AND WE ARE SPENDING IT!

Coming away from the auction, I stopped in the Harbor Bar, and a couple of drinks later, I found myself thinking the rupee could fall all the way to 50!

And I suddenly remembered an old friend of mine - Mr. O.P. Lohia, Chairman of Indo-Rama. Many years ago, when the rupee was still in its forever downtrend, I met with him and he said to me, "The rupee will NEVER reach 50 to the dollar." At the time, the rupee was at a then all-time low of around 47.50, and falling like a stone. Everybody and his brother knew that it was a matter of time before it hit 50. A prediction I had made in Baroda some 10 years prior to that looked like it would be coming true. I asked him why. He had a very grand and glorious and sensible explanation - starting with how the American era was over, how the Euro would, indeed, become a competing currency, how India was coming into its own, and how markets don't go one-way forever. [I remembered, at the time, a chart my father has behind his desk that said, specifically, Depressions Never Last Forever.] He had converted all his [significant] borrowings into dollars and was holding then unhedged. He made a lot of money, which was reflected in the share price of Indo Rama those years, and I never forgot the story [and, indeed, have dined on it, as well, several times since then.]

But, you know what? Never say never, Mr. Lohia. Maybe, just maybe, this turn of events is for you.

Of course, just thinking that the rupee could head towards - and, perhaps, hit - 50 to the dollar doesn't mean it will happen. But that's the joy - or one of the joys - of my job. I get to think of extravagant possibilities, since one of the key elements of risk management is to try and visualize scenarios that would require a shift in current thinking. Of course, my free thinking ways are - as they should be - subject to some rigor, and last Saturday, I walked into our fortnightly market meeting ready to terrorize all present with this thought.

Imagine my amazement when minutes after my bombshell, Pramod Maskeri, who is THE GREATEST MARKET GURU I HAVE EVER MET, excitedly, said, did you have a look at the statistics I sent you?

Here they are.

And here's his story. He said that the country's forex reserves have risen every year since 1995-96. This was despite the fact that the country's current account was in deficit every year till 2000-01. Clearly, there were sufficient inflows on the capital account to cover this deficit and - and this is the key point - RBI, in an overt export support operation, simply bought up dollars to keep the rupee either steady (when the dollar was weak overseas) or sliding. Of course, it was a small game (compared to today), the markets were relatively thin and exchange rate management was relatively simple.

By 2001-02, however, India's coming of age pushed our current account into surplus - ta da!

One immediate impact was a sharp increase in capital flows - investors, traditionally, assumed a certain currency depreciation when they invest in emerging markets, but once it became apparent - certainly by mid-2002 - that the rupee was going to actually appreciate, they flocked India-wards in droves. [Incidentally, inward remittances, which form part of the "invisibles" part of the current account, also started growing at a faster rate.] The surge in the capital account made it difficult for RBI to keep the rupee steady and, as we know, it turned upwards from 2002 onwards. The current account rally continued till 2003-04 - thank you NASSCOM - which, of course, triggered a further surge in the capital account and the rupee.

And now - 2004-05 - that the current account is back in the red, is it any surprise that the rupee is falling? And that RBI appears to be quite comfortable with this, to the extent that they are apparently no longer worried about the sharply rising volatility? [The volatility of the rupee, which has reached nearly 5%, compared to a long-term historic average of around 2%, has been rising for over 90 days, one of the longest such trends in history.]

The only question is "how much longer will the current account remain in the red"?

To which I, of course, answered, "Forever." Given that the domestic economy is just waking up, it is hard to see when our current account will turn to surplus again. And, this is a good thing, since a current account deficit is just what the doctor ordered for India. We are a capital short country, and running a current account deficit means we are importing capital. The big issue is, of course, whether we use that capital for consumption or for investment. If we use it for consumption, the rupee will fall; it we use if for investment, the rupee does not have to fall. [The U.S., of course, is an exception, since it imports capital freely for consumption, but its currency - at least right now - remains sky-high; this is largely because - at least as of now - the dollar is the world's reserve currency.]

Right now, it's hard to tell how much of our imported capital we are using for consumption and for investment. While my driver (and his friends) doubtless uses his credit card for consumption, he has also taken a housing loan to buy a flat (for investment). And all those art buyers - is art a purchase or an investment? In my view, it is largely a purchase, since a relatively small fraction of art turns around in the secondary market - but who's to tell?

On balance, I would feel that we are probably running a reasonable balance between consumption and investment, with perhaps a slight edge to consumption. Importantly, both of these are slated for major increases going forward. Which means the current account will continue in deficit.

And, the rupee - well, it will certainly remain soft.

Will it hit 50? Well, …maybe … maybe in 5 years.

But, and here's the good part - it won't be a one-way ride. If the dollar continues to confound all the pundits and remains strong into next year - my sense, incidentally, is that till a majority of analysts give up the ghost of a dollar collapse, it will remain on an uptrend - the rupee could weaken steadily, perhaps even reaching 47.50 or 48 by end 2006. If, on the other hand, the dollar does turn around - say, in response to a major collapse on Wall Street or a Nixonian political upheaval in the U.S. or some other major event (say, GM filing for bankruptcy) - we could see the rupee gain a few percentage points from its level at that time.
In other words, no easy answers but one - NEVER SAY NEVER!.

currency markets view: rupee and majors

INR

Fortnightly movement: O-45.74 H-46.24 L-45.66 C-46.18
Sentiment: bearish
Expected range for 1 Month: 45.85-46.75
Expected range for 3 Months: 46.00-47.25

With bearishness increasing, the rupee lost about 1% (44 paise) during the last fortnight. While it started the fortnight a bit firm, corporate dollar demand and dollar strength overseas generated gravity for the rupee's fall. The dollar would seem to have some more upside left before it hits the major resistances near 46.40-50 range, at which point we may see a technical correction.

Further out we see the rupee weaker [see analysis].

EUR

Fortnightly movement: O-1.1773 H- 1.1901 L-1.1659 C-1.1717
Sentiment - neutral, could improve
Expected range for 1 Month: 1.1600 -1.2100
Expected range for 3 Months: 1.1600-1.2300

Except for the larger than expected decline in US existing home sales, data from both the Eurozone and the US such as the German business confidence and inflation; US new home sales, consumer confidence, durable goods orders and sharp upward revision of US Q3 GDP were euro negative/dollar positive. Though ECB hiked its repo rate last Thursday, the ECB President doused any possible speculation of a series of rate hikes. Under the circumstances, the dollar's failure to push the euro below 1.16 might point to temporary fatigue on the part of dollar bulls or the customary caution ahead of the G-7 meeting.
The euro could still fall decisively below 1.16 this week but if it doesn't, the chances of euro rally over 1.19 are likely to have increased considerably.

GBP

Fortnightly movement: O-1.7167 H- 1.7376 L-1.7067 C-1.7328
Sentiment: neutral to slightly positive
Expected range for 1 Month: 1.7000-1.7600
Expected range for 3 Months: 1.7000-1.8000

Sterling did slide initially before finding support under 1.71. However, the unexpectedly smart recovery is due to quashing of Bank of England rate cut expectations following the release of the November MPC meeting minutes showing that the MPC was unanimous in deciding on a status quo and that there was even no discussion on a rate cut.
Sterling has, indeed, managed to close over the 1.73 resistance towards the end of last week. If it can stay over 1.73 for a few more days, it may probably rally further towards 1.75/1.76.

JPY

Fortnightly movement: O-119.15 H- 121.20 L-118.20 C-120.48
Sentiment: very negative (for yen)
Expected range for 1 Month: 115.00-122.50
Expected range for 3 Months: 113.75-122.50

When the Bank of Japan Governor reiterated the central bank's independence, the dollar eased to 118.20 but resumed its march after PM Koizumi's retort that with deflation still lurking it could be premature to end the ultra-easy monetary policy. This confirmed the ongoing feud between the Japanese central bank and the government. Poor inflation data and a rise in Japanese unemployment rate from 4.2% to 4.5% were also negative for the yen. As if all this was not enough, before heading for the weekend G-7 meeting in London, the Japanese FM said the yen's weakness reflected fundamentals. The dollar rose as high as 121.20 last Friday before retreating on a Reuters report (since denied) quoting US Tsy. Secy. John Snow as saying that the value of the yen would be discussed at the G-7 meeting.
The yen's rapid weakening may be of genuine concern to the US as it could, perhaps, lead to a delay in yuan revaluation which the US and all its G-7 partners very much want. Yet, the effectiveness of the G-7 meeting/communique is something that remains to be seen. Any signs of a yuan revaluation could prompt a rapid yen recovery.

N.B. Beware of higher volatiliy in thinning, year-end market conditions.