The Market's Will

ON Monday April 6, when the Bombay Stock Exchange Sensitive Index crashed by a whopping 167 points and rupee plummeted to a seven-month low—thanks to a raging Jayalalitha determined to secure her pound of flesh from the ruling coalition—the only people cheering were the heads of treasury operations at a few banks. Points out K.N. Dey, senior vice-president, Mecklai Financial & Commercial Services, a leading forex trading firm: "Monday's trading was purely speculator-driven. And between banks, some of which made a killing in the foreign exchange markets. Forex trade in the country is becoming increasingly inured to political rumours and threats of instability." That sentiment is echoed by the treasury head at a state-run bank, who feels that political seesaws could cause only a slight flutter in the market and "volatility, if at all, will be temporary". The central bank, he says, would keep the rupee safe.

He's right. Since August 1998, the Reserve Bank of India (RBI) has tightly reined in speculation and daily turnover in spot rupee-dollar trade has touched a paltry $100 million to $200 million of late. Last week was the first time this year that the rupee showed huge volatility against the greenback. The last time the Indian currency fluctuated wildly was in August last year, when the RBI hiked the repo rate by 3 percentage points and put a stop to arbitrage between the call and the forward markets (these curbs were relaxed later). On August 20, the rupee quoted at 42.82/92. In between, the forex market has been pretty quiet, thanks to an industry-friendly budget and regular announcements of reformist policies.

On Monday, however, Jayalalitha's threat saw the rupee at one stage plunge to 42.78 level, down 35 paise from the previous closing. But it closed higher at 42.68/70 as the RBI bought the rupee aggressively, with the market pegging the amount involved at between $50 million and $70 million. Dealers say the State Bank of India—which was seen buying dollars at lower levels—sold a good amount later. Finance secretary Vijay Kelkar's hinting at a depreciation of the rupee at a CII gathering on the same day also put pressure on the currency.

Says Gautam Ashra, partner at forex brokerage house Kanji Pitamber & Co: "A large number of banks went short on the dollar thinking that the RBI would intervene at 42.40. But the central bank came in much later." Dealers are confident that ultimately, the rupee will retrace part of the loss suffered so far. Adds P.H. Ravikumar, executive vice-president at ICICI Bank: "In the short term, the RBI has enough ammunition to handle any pressure on the rupee."

A large part of that ammunition is the very comfortable foreign exchange reserves of over $31 billion. This means that the central bank can afford to pump in as much as $3.1 billion, following a finance ministry-RBI joint decision to cap intervention at 10 per cent of reserves. Second, the RBI has recently mopped up a lot of excess liquidity from a funds-flush system—Rs 3,000 crore by way of an auction of 10-year government bonds and another Rs 3,000 crore through the private placement of 14-year paper by the government.

Dey feels that even without the RBI's sustained intervention, speculation alone will not push the rupee down. "Even this week, banks started buying dollars hoping that corporates, especially importers, would join their efforts. However, importers are well covered now and are hedging their foreign exchange requirements prudently. On the contrary, exporters are using the forex market for their gains. The fact that forward premia on dollar—now around 7 per cent—has not gone up much and only the spot rupee-dollar rate is fluctuating proves that speculators are at work. If cor-porates had panicked, it would have pushed forward premia up."

Indeed, during 1997-98 and 1998-99, the rupee dipped by 6.5 per cent, while forward premia on dollar hovered between 7 and 9 per cent. The other factor working on the forward premia is an RBI stipulation meant to curb speculation by importers. Currently, if an importer has bought dollars at three months forward, he is not allowed to re-trade on this purchase till the three months are over. This stipulation, which took effect for trade accounts in August, was extended to non-trade accounts in January. Says Dey: "The April 20 credit policy was expected to do away with this clause, but now I feel the RBI might continue with it for some more time."

As a result, the rupee has stayed its ground in the past eight months, despite gold imports having gone up almost eightfold (around $6 billion). Apart from the $4 billion that came into the country through the Resurgent India Bonds, dollars earned on software exports also have helped prop up the rupee. The largest forex drain, the oil pool account, is in surplus at the moment as well. Although oil prices have hardened of late to $14 a barrel, the effect of this will only be felt in the second quarter of 1999-2000.

But forex dealers, who feel that the government should not force the hand of the forex market, are a trifle dismayed by Kelkar's indication of a rupee devaluation. Says J. Moses Harding, head, forex treasury, IndusInd Bank: "The exchange rate alone doesn't contribute to exports growth." Kelkar's hint also goes against commerce minister Ramakrishna Hegde's statement in Mumbai last week. "Let the market forces decide the rupee-dollar parity," he said. Financial market circles feel that a 5 per cent devaluation over a year might not be a bad idea. And that's exactly what may happen soon.

In a poll conducted recently by Mecklai Financial & Commercial Services among 450 respondents belonging to the forex industry, the finan-cial market estimated that the rupee would touch Rs 43 to a dollar by September 1999 and Rs 44 by March, 2000. A little over a third of corporates and transnationals, banks and foreign institutional investors polled believed that the dollar-rupee rate would breach 45 by March 2000. The respondents also felt that domestic factors like the state of the economy and dull export growth were affecting the rupee more than global events. Interestingly, the poll also showed both importers and exporters having similar expectations for the rupee-dollar values.

Sums up Jamal Mecklai: "Sentiment is an elusive beast. Whatever be the underlying fundamentals, the most important question is: what does the market expect of the rupee? Because if a large section of us expect the rupee to trade at, let's say 45, then it will come to touch that level."