Rupee could fall steadily in next four months

If the market starts getting nervous about the political risk factor, currency depreciation could be a lot more severe, says Devangshu Datta.

The swap window that the Reserve Bank of India (RBI) opened for the oil marketing companies (OMCs) in August has officially been closed. This has interesting implications. In August, the rupee was in free fall. It dipped below 68 versus the dollar in late August. 

At that stage, RBI started offering dollar directly to OMCs, keeping the forex demand for crude purchases off the open market to shield the rupee. The OMCs have to return the dollars to RBI at some stage, presumably by buying off the market. 

The second leg of the swap, the return of currency, will occur sometime in February-April 2014.

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The OMCs buy $8-9 billion every month. Between August and October, these apparently bought everything from the RBI special window.

In November, these bought about 70 per cent of requirements from RBI and sourced $3 billion directly from the market. A ballpark estimate would suggest the OMCs have, therefore, swapped $25-30 billion odd with RBI. 

One key factor is that swaps normally reverse at exactly the same exchange rates (there might be interest rates involved as well).

We don’t know the exchange rates. The  dollar has fluctuated inside the band of 60.75- 68.35 in this  August-December period. We don’t know what interest rates, if any, were involved. Nor do we know what the going prices of dollar-rupee will be when the swaps are closed out. 

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If the market rates are substantially different when the swaps are reversed, either  RBI or the OMCs will take hits. If the OMCs get hit, that will put further pressure on their fragile financials.

RBI reserves the right to be flexible, of course. It may reopen the swap window if required and also roll over the swaps if strange things are happening in the forex markets when those are to be reversed. 

However, assuming the reverse happens as scheduled, the OMCs will roughly double their  dollar buying.

However these do it, there will be heightened dollar demand through much of the last quarter of this financial year. That will also be the time when global markets will become increasingly nervous because the US Fed will either be tapering QE3 or contemplate doing so. 

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India’s forex reserves have improved. The sense of panic that existed in August has eased. Also, the FCNR and foreign  bank deposit swap schemes have together brought in some $34 billion.

This doesn’t technically count as reserves but it’s sitting there with RBI. The current account deficit has shrunk considerably.

RBI is also implicitly relying on foreign institutional investors remaining positive on India and, thus, bringing in forex via the portfolio route.

Despite all this, external obligations continue to remain higher than reserves, though short-term external obligations can be easily covered. 

There is no real fear of a run on the rupee. But there could be a steady trend of the rupee falling lower through the next four months.

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It has trended between 61.65 and 63.65 in the past 20 sessions. Breakouts from this range could take it down to the 65 level or even lower.

If the market starts getting nervous about the political risk factor, the currency depreciation could be a lot more and it could be more jerky. 

Such a downtrend, if it occurs, will have predictable consequences, given that we’ve already seen the macroeconomic response to a weaker rupee over the past several months. Exports should grow strongly while imports get squeezed somewhat more. 

Exporters could well beat their own projections over Q4. Businesses supplying the domestic market with goods will also receive some protection from imports and might see improved offtake and better margins as well.

Traders could, depending on their inclinations, bet on the US dollar relationship or on various listed companies which will be the beneficiaries.