By Amrit Basu
The markets the world over are in bad shape. Be it the stocks, currencies or even the neighbourhood groceries market. Everybody is affected by prices probably for the first time after long of some like petrol and vegetables while they are up or of, say, stocks while these are down. It's no coincidence that the people who are enjoying are the commodities people the majority of the readers of this publication.

We would, however, like to restrict our discussion to the currencies, more particularly our own Indian rupee. Not very far, I was one of the people who were seeing the rupee appreciating beyond 39 against dollar. But just when I was able to justify my view telling various readers/callers statistics left, right and centre, like most analysts, I was immediately proved wrong, as the rupee started depreciating fast, really fast; so much so that, the currency lost more than 10% in less than six months.
Source www.dollar-rupee.com

So, what exactly went wrong? I am just trying to analyze. Well, almost everything went wrong.

OIL
The cruelest shock came from the crudest of it all the crude. When people started talking of Brent and Nymex in family discussions, one knew things were not going to be easy. While we were around $130 per barrel, the word came from the horse's (read the OPEC chairman) mouth that speculations may take oil to $170. Despite the well-known Saudi muscle of spare capacity and the definiteness of the US inventories, the journey to that level started quite earnestly.

Imagine, we were complaining at the breach of $16 or so fifteen years back! So far, so good. But how does the rise in oil prices affect the Indian rupee. The reason is very simple. Assume, for instance, the demand for oil in the country remains constant (we are just assuming, not day-dreaming). This means for the same barrel of oil, while earlier we were paying $100, we would be paying, say, $140 now. That means there is an additional demand of US dollars 40, which needs to be raised from the market. This pushes the price of the dollar at the cost of the rupee. There, we are. And one shudders when one thinks of some forecasts of $200.

STOCKS
Let us talk about the stocks. Here, it's a double whammy. If the perception in the eyes of the investors (FIIs, for example) is that the stocks are tanking, they would like to pull out of those markets, where the downturn may be faster. In such a scenario, they sell their holdings, and take the proceeds (naturally in foreign currencies) back to their home country to stay liquid in cash till the situation or the perception changes. Since they take the proceeds in foreign currency, there is pressure on the local currency. The matter does not end here. Even as the FIIs start pulling out, the index slips and the domestic investors (who normally are late to react) panic. And, they sell.

INFLATION
A few months back, we had just under 5% inflation. And we were smiling with confidence. A new India shining, maybe. And all was hunky-dory. Truly so, since all sectors of the country were out-performing. But the villain, that is oil, played the spoil-sport. We suddenly, in a month or two, touched double digits. With price of oil in the international market soaring, it was absolutely untenable for the government not to intervene and raise the administered prices of the petroleum products (leaving aside kerosene, for obvious reasons).

And with this, the cost of transport, which is a major portion of the prices of vegetables, groceries etc, rose. And to add to this, world-wide food prices started going up, for the same reasons, though one of the reasons is the rising living standards of the emerging economies, which contributed to the demand all around. It was a heady-mix of cost-push through petroleum prices, and demand-pull through the changed dimensions in the needs and demands of most of us on the new world of emerging economies. What it meant for us that the savings got a hit, even as people not only couldn't save more, but also resorted to depending on the existing savings, to maintain the lifestyle they have been accustomed to of late.

CENTRAL BANK
But the law of economics says, if there is inflation, the central bank intervenes with monetary measures to stem the same, by increasing interest rates as well as by sucking out liquidity from the system. This, the Reserve Bank of India did and is probably planning to continue to do.

The downside here is that the growth which we have been seeing for more than four years is also getting a hit, because of high interest rates and less liquidity. The question is why the Indian rupee is depreciating when the money has become dearer? The answer is that there is a lag time for the measures to take effect. The other fact is that the Indian rupee is not always a follower of law of economics. There are extraneous factors which outweigh the laws of economics while determining the price of the currency.

One more important factor is the 'comfort' level of the central bank, which in its wisdom, after watching various markets and situations obtaining in the country and elsewhere, decides to defend the currency. If the currency is depreciating, one way to defend it is to buy it by utilising the foreign exchange reserves. The Reserve Bank of India, in its report on foreign exchange reserves:

Position as on 31 March, 2008 says: “The level of foreign exchange reserves, which comprises the foreign currency assets, special drawing rights, Gold and the reserve tranche position in the IMF, had steadily increased from $5.8 billion as at end-March 1991 to $151.6 billion by end-March 2006 and further to $199.2 billion by end-March 2007. It stood at $309.7 billion as at end-March 2008.” While we see the Reserve Bank intervening off and on in the foreign exchange market to arrest the unusual fall or rise of the Indian rupee, I would assume that they definitely have a policy on when to intervene and when not to. As a result, we do not venture to doubt its efficacy, but would let the market speculate on the timing.

POLITICAL STABILITY
This is the joker in the pack. Lot depends on the political stability of a country. Whatever opinion one may have on the much-maligned 'nuclear deal', what we need is stability of the government, of whatever dispensation. Sooner the political actors realize this, it is better for all of us. I am also very hopeful here, as the Indian electorate has this uncanny control on the country's politics. It may take five years to change a government or give a fresh life to a party in power, but the common citizen knows where the future of the country would remain safe. So earlier, we have the elections; it would be good for the economy.
GLOBAL ECONOMY
The woes are not India-specific. The gloom is world over. This is best described by Reserve bank in its annual policy (2008-2009) statement. “Global economic activity decelerated somewhat in relation to earlier expectations, mainly on account of the slowdown in the US economy. During the first quarter of 2008, the unfolding of the subprime mortgage crisis coupled with growing concerns about a contraction of economic activity in the US in 2008 appears to be feeding into a deterioration in the outlook for global growth which has remained relatively resilient so far.

There are some signs that the slowdown in the US may spill over to the Euro area, China and Japan with potential implications for the emerging market economies (EMEs) through trade, financial markets and other linkages. According to the World Economic Outlook (WEO) of the International Monetary Fund (IMF) released in April 2008, the forecast for global real GDP growth, on a purchasing power parity basis, is expected to slow from 4.9 per cent in 2007 to 3.7 per cent in 2008 as compared with the projection of 4.1 per cent published in January 2008 and 3.8 per cent in 2009. World real GDP growth, on the basis of market exchange rates, is estimated to decelerate from 3.7 per cent in 2007 to 2.6 per cent in 2008 and 2009.

PRICE ACTION
This is one of the most important factors in determining the price of a currency. This is the culmination of the needs/requirements, pushes/pulls, demand/supply of all the players in the market the government, the central bank, the investors both domestic and overseas, common citizens like you and me, various lobbies and above all speculators.

When we see the price action in US dollar versus the Indian rupee, we can surmise that a broad range of 42.6000 to 43.4000 has been formed, with a bias to the downside being more prominent, at the time of writing this piece. We have probably seen a top already; but will not hazard a guess here. There is all likelihood of overshooting the above range on the upside. Most currency watchers predict a move to 44.5000. While I would not agree with this view, I would wait till the next elections to have a new target in mind.

WHAT NOW
We expect that the world economy will slowly come back on rail, even as the sub-prime crisis effects take time to heal. I am also mildly confident that oil would not go as high as $150 and beyond, at least not in the very short-term. This would help prices stabilize in all sectors. And as said earlier, the elections and the subsequent (hopefully) stability, will help the rupee appreciate.

But as a matter of abundant precaution would not advise any speculation in Indian rupee as this is the most difficult of the currencies to predict and trade. •

Amrit K Basu is a Foreign Exchange Consultant and the Head Treasury Products & Strategies of proFX consulting & allied services, a Treasury Risk Management consultancy outfit. Amrit is also engaged in offering advisory to software companies as well as in placements in the treasury domain. He can be reached at amritbasu@profxconsulting.in.

This article published in COMMODITY MARKET, India’s No 1 news magazine on commodities.