The rupee has recovered somewhat after collapsing against the dollar but volatility remains high. Prudent exporting companies that hedged have faced significant mark-to-market losses on their hedges as an opportunity cost, while importing companies without hedges have faced real losses from the weaker rupee. For importers to recover, the rupee would need to strengthen further but volatility is likely to persist due to unhedged imports and external factors. The author concludes that the spot rupee rate will fluctuate around current levels for some time.

1. 12/7/11 .business-standard.com/india/printpage.php?autono=454457&tp=
Ja a Mec ai: Rupee volatilit - Keep on
pra ing
While the rupee has recovered som ew hat, volatilit and nervousness
rem ain high
Jam al Mecklai / Novem ber 4, 2011, 0:26 IST
The near-vertical rise in rupee volatility (from 5.4 per cent
to 9.5 per cent) since mid-August, accompanied by a
collapse in the rupee to below 50 to the dollar, has rattled
most companies. While the rupee has recovered
somewhat, volatility – and nervousness – remains high.
Prudent companies – mostly exporters, who have
hedged a good part of their receivables – have been hit
through significant mark-to-market losses on their hedges. Of course, these
losses are not real — to quote Narayana Murthy, “Cash is real, profits are an
opinion.”
Clearly, most companies that hedged exports did so at rates that ensured
their profitability — the foreign exchange loss in their books represents only
an opportunity loss. While most companies have recognised that this
opportunity cost is merely the price of conservative risk management, the
scale of the cost this time has many companies reassessing their foreign
exchange policies, However, few companies would look to return to the fully
unhedged approach under which they could capture all of the opportunity
(and, correspondingly, run all of the risk). Incidentally, I was very pleased to
note that in our 2011 annual risk management survey, fully 80 per cent of
respondents reported that they separate cash performance from accounting
performance. Many companies now also prepare a reconciliation statement
on the subject as part of their quarterly reports.
Much worse off are companies with short dollar positions – importers – who
remained largely unhedged because it appeared that the good times – a
steady to slightly stronger rupee – would last forever. Indeed, many
companies with commodity-type imports were further leveraging their
apparent good fortune, by layering buyers credit on top of their existing
supplier credits and often rolling these over as well. The hit to their accounts
is real, unless, of course, the rupee recovers dramatically before their credit
periods run out. This may explain the increasingly loud sound of prayers
wafting up this past Diwali.
I guess, the big question is: what is the likelihood of the rupee recovering
sufficiently to where at least some of these companies can get out of the
woods?
The good news is that the European crisis appears to have shifted to a “sigh
of relief” mode, with last week s agreement on restructuring Greek debt. The
euro shot higher carrying the rupee part of the way with it. Technically, the
euro move appears to still have some room to go, which suggests that the
rupee, too, could rise a bit further. News that China may be buying euros
could also keep it well bid.
This tentative return to the risk-on investment mode has attracted foreign
institutional investors (FIIs) back to Indian markets, and, with the Reserve
Bank of India (RBI) signalling that its tightening cycle is at or close to over,
there is likely to be continued demand for both domestic equities (which are
quite reasonably valued) and, importantly, debt. The RBI should further
increase the FII limit for debt investments, or, at least, take away the silos into
which investment is permitted.
Encouragingly, the economy appears to be shrugging off the pessimistic
.business-standard.com/india/printpage.php?autono=454457&tp= 1/2

2. 12/7/11 .business-standard.com/india/printpage.php?autono=454457&tp=
mood generated by the continuing corruption scandals and the woeful mood
in global markets. At a Diwali party, I found myself telling a friend that we will
certainly see new highs on the Sensex this year 23,000 by next Diwali?
All of this could, of course, boost the rupee.
On the other side, however, is the huge amount of already consumed imports
that have been financed with global credit, and not yet paid for in the foreign
exchange market. It is hard to estimate volumes, but if we assume that one-
third of our imports over the past six months have been rolled over and not yet
hedged a relatively aggressive assumption, considering how difficult it is to
find vacant bank limits for India that would total about $60-65 billion of
imports yet to be paid for. Adding this to the monthly trade deficit of $6-8
billion means that services exports, external commercial borrowings and
capital flows have to run at around $10 billion a month just to keep things
steady.
While this is certainly in the realm of possibility, it is a tall order. The only
certainty is that volatility will remain high as hot spots of excess payments
(defence, oil, etc) or, of course, more euro-zone wobbles, will keep triggering
bouts of rupee weakness.
In fact, looking at the way rupee volatility has been moving, it appears close to
a peak (at around 9.5 per cent); if this is true, it will need to hold around this
level for the volatility to come down. This suggests that the spot will simply
jockey around the current levels for a few more months before we see any
definitive new trend.
Keep on praying.
jamal@mecklai.com
.business-standard.com/india/printpage.php?autono=454457&tp= 2/2