Manis Thanawala: Importers Must Not Expect Rupee Appreciation in 2014

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Ask me if traders in the forex market expected a big fall in the Indian rupee and my answer will be yes. It was the magnitude of the fall that really shocked everyone.

The news of tapering as well as the flight of capital from the debt market did the trick. By the first week of July, the rupee had already touched the 60-mark. The market was full of doom and gloom where some said that it might even touch 75. What is strange is that everyone started to talk about the current account deficit (CAD) and inflation numbers only after the fall and when the rupee touched Rs 61.20, the market truly panicked.

If you look at the emerging markets in Asia, India is the only economy with a CAD. Thailand, Malaysia, Korea and even Philippines are all current account surplus.

Now 2008 had experienced a global financial crisis where the rupee had become volatile. But 2013 was different. This time it was as much about India because we had a deficit which was being funded by foreign flows and suddenly we had a situation where the guys filling this hole backed out. This had an adverse effect on the exchange rate.

Everyone knows that CAD and FII exits are the starting points for triggers in the forex markets. This is also the time when importers start to panic. In 2008, exporters were hedged through five-year forwards while importers had open positions. When the markets crashed, importers were in trouble. In 2011, there was a small crisis where the rupee moved from Rs 53 to Rs 59. Again, the importers were caught in a mess as they had not hedged their position. In 2013, we had expected that the importers would have learned their lesson but most of them continued to have open positions.

Importers want to cost their commodity at the spot price rather than pay extra for hedging. This way, they under-price their commodity and sell it in the local market. Their objective is to earn the differential between the 2 percent dollar interest rate and the 10 percent rupee interest rate and make money. So when the exchange rate moves, the domestic guy gets wiped out.

When the rupee moved towards 70, we thought that the move was overdone. Buying forwards was risky because you would not be in a position to exit. We told importers to buy options, which many did: They bought a simple call option and even paid a large premium on it. When the rupee was volatile, the two-year at-the-money spot option premium and two-year forward points were only 20 paisa apart.

What next? Everything now depends on the elections. We don’t expect heavy FII inflows as we near the poll date. We have issues related to CAD but the good news is that the effect of gold imports is taken care of through the curbing of imports.

It is difficult to take a call independently on the rupee because people are taking bets on the elections. If the BJP comes to power then it will be positive for the rupee. If it is the Congress then the movement will be neutral. And if there is a third front, then I don’t know what will happen.

While most forex traders don’t see much happening for the next six months, they have started to hedge more as compared to earlier. Overall, though, the chance of further appreciation is low ahead of elections.

(As told to Pravin Palande)