WHEN THE BOTTOM ALMOST FELL OUT OF THE CURRENCY
A late rally notwithstanding, the rupee ended up being the worst performer among emerging market currencies this year, giving up almost a fourth of its value
TREASURERS had been looking forward to a fairly peaceful 2013, but, in the end, it turned out to be a more tumultuous time than anyone had imagined. To be sure, they hadn’t expected either the bond or currency markets to really behave themselves, but neither had they anticipated the kind of damage that both saw through the year.
Indeed, 2013 was a harrowing year as they stayed glued to their screens, tracking the trajectory of the rupee, trying to predict the course of the currency, but getting it wrong more often than not. Dealing rooms, they recall, hadn’t seen so much action in a decade—certainly not the kind of roller-coaster ride the rupee took — when even taking a tea-break during trading hours was a risk.
Ultimately, the currency made history as the rupee fell to its lowest levels in late August — much of it thanks to the strength of the dollar, the rest the work of speculators. The Indian currency, however, stopped short of the 70 mark many currency watchers feared it would hit against the greenback. But, by then, much of the damage had been done; importers who hadn’t bought their dollars were in deep trouble as were corporates with an unhedged exposure to foreign currency loans.
Indeed, so little was the faith left in the strength of the currency that few expected it would ever rally again. But rally it did, making a stunning comeback by the end of the year, gaining 11% from the low of 68.85 after the Reserve Bank of India (RBI) swung into action with a host of measures that bolstered India’s reserves by $34 billion from inflows of foreign currency deposits.
The late rally notwithstanding, the rupee ended up being the worst perfor mer among emerging market currencies last year, giving up almost a fourth of its value and pushing India into the club of the ‘Fragile Five’; the Brazil- ian real was close behind, having lost about a fifth of its value. And while the central bank’s measures did pay off, the Indian currency might not have had the kind of safe landing it did had fears of the taper by the US Federal Reserve not eased by the end of the year.
Treasurers recall how the fall began when talk of the tapering first surfaced in midMay and US Federal Reserve chief Ben Bernanke indicated that the quantitative easing programme — $85 billion a month at the time — might be reduced. They remember how turbulent the markets were in May, June and July, how severely the currency was jolted, plummeting 23% between May and August as yields on the US treasury benchmark rose a 100 basis points.
July was the month when the central bank decided it was time to act and dealing rooms braced for tough measures. Banks were banned from taking proprietary positions in ru- pee futures and open positions were curtailed.
Imports of gold were tightened and, in a move aimed at keeping liquidity in check, banks were allowed to borrow just 0.5% of deposits from the Reserve Bank.
The central bank had tried to make life easier for foreign institutional investors (FII) by simplifying the systems. But once yields on US treasuries soared, there was no stopping them; in a matter of months, $12 billion was gone.
The outflows weren’t just restricted to the bond markets — equity inflows that had been clocking $2-3 billion a month dwindled to just $200 million in June. July and August saw some $2.2 billion move out and, on August 28, the rupee hit a historic low, closing the session at 68.85.
Interestingly, the unhinged expectations on the movement of the currency were reflected both onshore and offshore. The rupee's 9% fall between May and July, and relatively easy access to liquidity in the home market, saw speculators getting into action in the home market. In fact, the RBI raised the Marginal Standing Facility rate by 200 basis points to 10.25% in a move to tighten liquidity.
However, the trend in the non-deliverable forwards (NDF) market was bearish; this rupee-dollar market has grown a fair bit over the last five years with volumes overtaking those onshore. Away from the Reserve Bank’s attention, the NDF market, dealers point out, was a good hunting ground for anyone wanting to punt on the rupee; when the rupee weakened to 60 levels in July, rates in the NDF market were already reflecting a fall to 68 in a month.
However, the central bank’s move to pull the ‘oil demand’ — the dollars that oil marketing companies buy to pay for purchases of crude oil — out of the currency market and allow OMCs to access a special dollar window did buoy the sentiment since it meant the demand for dollars would drop by a good $10 billion every month.
A change of guard at the RBI in early September when Raghuram Rajan took over as gover nor also made a difference; banks were allowed to tap foreign currency non-resident deposits at an attractive swap rate.
Later in the month, the central bank allowed foreign institutional investors to buy gilts on tap rather than just ‘limits’ that needed to be converted into purchases of bonds. Dealers were taken aback when, in the second week of November, Raghuram Rajan announced the ‘oil demand’ had retur ned to the market for almost a month, something the market hadn’t even got wind of.
What put short-sellers on the back foot was his willingness to settle dollar demands of oil marketing companies in rupees. With FIIs finally back in the market in December, it was clear the tactics had worked; it was going to be a merry Christmas after all.