Rupee at historic low; why is it falling?

The Indian rupee on Friday depreciated to an all-time low of 50.69 against the US dollar in early trade on continued capital outflow by foreign funds and increased dollar demand from importers.
At the Interbank Foreign Exchange (Forex) market, the domestic currency was quoted at 50.69 against the dollar, down 23 paise from its previous day's close.
Dealers said concerns of capital outflows by funds and increased demand for dollar from importers caused the rupee to weaken. They added that the dollar's gains against other major currencies also weighed on the domestic currency.
So what are the other reasons for the fall of the Indian currency?
Higher crude oil prices too have weighed in on sentiment. Oil refiners are amongst the biggest dollar buyers in the Indian currency market and the demand especially is at the high towards the end of a month as they make the payments for their imports.
Even a dip in the inflation figure did not help the rupee rise slightly. Inflation declined to about a 15-month low of 3.36 per cent mainly due to fall in the prices food articles like fruit and vegetables, pulses, and some manufactured items, raising hopes of cuts in the key policy rates by the Reserve Bank of India.
Meanwhile, the outlook downgrade by rating agency Standard & Poor's too has increased the risk of further depreciation of the rupee in the near term. S&P cut its outlook on India's long-term sovereign credit rating to negative from stable on Tuesday, citing worsening government finances, which could raise firms' overseas borrowing costs and weaken the rupee.
Morgan Stanley has predicted that the rupee could test 52-53 levels in the next 4 to 6 months on balance of payments pressures.
Demand for rupees, simultaneously, has dipped because capital inflows are down. The American sub-prime crisis that shook the global financial markets has seen unprecedented bailouts and infusion of dollars into the US economy.
This infusion has been at a cost of many an emerging market, from where funds have been pulled out to plough back into America.
India has been one of the worst hit countries on this count, as foreign funds took flight, thereby making dollars scarce. The sudden and colossal demand for the US greenback has seen it strengthen, while the rupee's exchange rate has depreciated dramatically during the same period.
India's stock market regulator, the Securities and Exchange Board of India, has said that foreign investors sold more Indian shares than they bought.
Global funds are said to have sold Indian shares to the tune of over $12 billion more than they have bought during the last few months year.
As demand for dollars from importers increased and the US Treasury poured in hundreds of billions of dollars into the floundering US economy to bail out drowning financial giants, the Indian market saw an outflow of a huge amount of dollars leading to a spurt in the dollar price against the rupee.
The growing Indian trade deficit and the large fiscal deficit are also contributing to the fall of the rupee. The demand-supply balance and the fundamentals are against the rupee.
One more reason for the fall of the rupee, as propounded by some economists, is the overseas non-deliverable forward (NDF) market that is not sanctioned by the Reserve Bank of India.
An NDF is a non-deliverable forward contract where financial institutions buy forward dollars (that is, they book dollars now for delivery at a predetermined future date) in the Indian market and at the same time sell a similar amount of dollars in an overseas market -- or vice-versa -- so that on the delivery date they make a profit or loss, which is the difference between both the rates.
The recruitment process for these jobs is expected to start soon.
How can India control the value of the rupee in the international market?
The Reserve Bank of India can sell dollars in the open market to bring down the value of the US greenback, albeit slightly.
Normally, the RBI uses its Monetary Policy to defend the rupee's value. Short-term interest rates changes do impact the value of the rupee against other currencies. But, the RBI has mostly used the policy to stabilise internal conditions, like steps to control rising inflation.
However, if the Indian stock markets boom -- like they did in 2007 -- more global funds would begin to invest in India thereby strengthening the rupee as the demand for the dollar in the local markets drops.
What has the RBI done?
The Reserve Bank of India is closely monitoring the developments in the global as well as domestic financial markets and stands ready to take such pre-emptive action as may be necessary to contain excess volatility in the domestic financial markets.
In order to alleviate these transient pressures which are related largely to external developments, the RBI has decided to take the following measures:
(a) Forex Market
In the light of current developments in the foreign exchange markets, as on some previous occasions, the Reserve Bank will continue to sell foreign exchange (US dollar) through agent banks to augment supply in the domestic foreign exchange market or intervene directly to meet any demand-supply gaps. The Reserve Bank would either sell the foreign exchange directly or advise the bank concerned to buy it in the market. All the transactions by the Reserve Bank will be at the prevailing market rates and as per market practice.
(b) Interest Rates on FCNR (B) Deposits
Currently, the interest rate ceiling on FCNR (B) deposits of all maturities has been fixed at Libor/Euribor/Swap rates for the corresponding maturities minus 75 basis points for the respective foreign currencies. In view of the prevailing market conditions, it has been decided: to increase, with immediate effect, the interest rate ceiling on FCNR (B) deposits by 50 basis points, i.e., to Libor/Euribor/Swap rates minus 25 basis points; and to increase, with immediate effect, the interest rate ceiling on NR(E)RA deposits by 50 basis points, i.e., to Libor/Euribor/Swap rates plus 50 basis points.
But why do currency values fluctuate?
There are many participants in any foreign exchange market. These entities -- like banks, corporations, brokers, even individuals -- buy and sell currencies everyday.
Here too the universal economic law of demand and supply is applicable: when there are more buyers for a currency than sellers, its exchange rate rises.
Similarly, when there are more sellers of a particular currency than buyers, its exchange rate in the global markets will fall. This does not mean people no longer want money; it only means that people prefer to keep their wealth in some other form or another currency.

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The Rupee and your investments

For some time now, Indians have been warming up to the idea of investing overseas and diversifying their portfolios across geographies. Over the last few years, many international mutual funds were launched to cater to this growing market, which has a combined asset-size of Rs 6,598 crore. Besides, Indians already have a big appetite for universal commodities like gold and silver. And many investors are also increasingly dabbling in commodities such as crude oil and copper. While this is good for your portfolio as it gives you the benefit of diversification across asset classes, and across geographies, it also exposes you to the vagaries of the currency movements. In recent times, rupee-dollar rate has gained significance because of the rapid decline of the Indian currency against the greenback since the beginning of this year.Says Ramchandran Krishnan, Director and Chief Investment Officer, Barclays Wealth: “When you invest overseas, a part of your returns is linked to currency movements. You can’t be indifferent to these fluctuations.”

The Rupee factor

Currency movements can adversely affect your returns even if your underlying investment has performed well. Here’s how the rupee movements can make a dent on your returns: Suppose, you invest in a US company that pays a dividend in US dollars. Also, assume that during the time you are holding the stock, the US dollar appreciates against the Indian rupee by 10 per cent. If the US-based company declares dividends, it will now be worth 10 per cent more in rupee terms, due to the appreciating dollar. Even if you assume that your company declares no dividend and its stock price remains constant during the same period, you will be richer by 10 per cent in rupee terms. Any appreciation of the foreign currency of the country that you are invested in increases the rupee rate of return. Likewise, any depreciation in the currency of the country that you are invested in, will result in a loss.Since the beginning of this calendar year, the dollar has appreciated 23 per cent against the rupee as the demand for dollars has increased. Foreign investors began to sell their holdings, and higher crude prices forced oil companies to buy more dollars to fund their imports and repatriate their investments. Had you invested in a dollar-denominated investment (assuming its capital value was constant), your investments would have appreciated in rupee terms in the same period. But, of course, predicting where the rupee will go against the dollar is a tricky business. Yet, the basic tenet about investing in other countries or international commodities, apart from the fact that the assets should have a strong future, is to be invested in an appreciating currency. If the rupee is going to be strong against the US dollar, it’s better to remain invested in rupee assets such as local stocksBenefits of hedgingCurrency futures can help stem losses in international markets.For investors, currency futures might be a way to hedge their international exposures. Currency futures were introduced in India on October 1, 2008. It has since gained momentum and its volumes are steadily picking up, trading up to 150,000 contracts every day. Currently, only rupee-dollar futures are allowed in the Indian markets. Investors can hedge their international exposures to dollar assets by buying and selling rupee-dollar futures. Experts feel that investors with knowledge of the international markets can use currency futures to their advantage. Says Iyer: “In a volatile market, currency futures do have a role to play. But you need to have some kind of comfort with the futures market, and know the risks involved with these markets.”Investors can hedge their dollar assets in rupee-dollar futures. It allows investors to reduce exposures to fluctuations in the home currency by taking out a hedge in the forex market, and it is one more important tool in your risk-reduction arsenal.

Twin-edged gains

If you invest in commodities that have universal demand like gold (either in physical form or through an exchange traded fund) or silver, your returns are linked not only to the price of the underlying asset but also to the rupee-dollar value. A depreciating rupee will increase your rupee returns on your gold investments. In fact, many investors have gained despite a fall in the price of gold. While the price of gold decreased 12.3 per cent from $846 per ounce on January 1, 2008 to $730 per ounce (London PM fix) on October 31, 2008, the rupee price actually increased from Rs 33,389 per ounce to Rs 36,136, due to the decline in the rupee against the dollar as per statistics from the World Gold Council.But not many Indian investors are following the price of gold in international markets or comparing it to the rupee-dollar movements. That’s because Indians have held a traditional fancy for gold that extends beyond just investments—it’s also a sentimental buy. Besides, many Indian buyers are sensitive to the rupee rate of gold. Says Lakshmi Iyer, Head, Fixed Income & Products, Kotak Mutual Fund: “There’s a rupee correlation for gold prices. But Indians buy gold more due to its sentimental value. At very high prices, there’s a stiff resistance to buying gold.”

The overseas game plan

Overseas mutual funds, on the other hand, are mostly dollardenominated, and, hence, their returns are linked to the rupeedollar movement. While there has been a global sell-off in emerging market funds, international funds, too, were affected in the financial meltdown. But a back-ofthe-envelope calculation suggests that in the last one year (till November 3, 2008), the average returns of international funds (with an exposure of over 65 per cent in the overseas markets) were down 43 per cent. This is despite many foreign stock market indices being harder hit, when compared to the Sensex, which is down 47 per cent over the same period. The downside was in part cushioned by the dollar appreciating against the rupee.The rupee-dollar rate may remain volatile till the global economic situation stabilises; so, investors will do well to keep an eye on the currency market. Savvy investors, particularly high-net worth investors and those who are clued in to currency movements, can also take a hedge against the dollar in the Indian market—which were recently allowed in the country— although currency futures is for the moment restricted only to the US dollar. Says Krishnan: “If you are comfortable with a currency, then you may want to take a hedge.”However, investors should put on hold investments in foreign equity or other assets such as real estate for now. Says Krishnan: “The global slowdown will affect the performance of overseas asset classes. Investors can look at other emerging markets instead.”Over the next few months, the currency markets could become more volatile as the global economy goes through the after-effects of the financial crisis. Your portfolio may not necessarily be directly affected if all your assets are denominated in rupees. If you have gold and other overseas assets in your portfolio, keep a close watch on currency movements, unless you are extremely confident of your asset class.

The paradox of rupee returns

How rupee fluctuations affect your investment.

• If the rupee falls in value, the rupee returns on commodities such as gold increase, (assuming that international gold prices remain constant)

• If the rupee appreciates in value, the rupee returns on gold decline

• An investment in overseas assets will fall in value if the underlying currency depreciates, and investors will tend to lose out

• But a strengthening currency will result in gains for investors in overseas assets such as property and bonds (assuming that asset prices remain constant)

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