Volatility in the value of a currency is the delight of traders but hated by both importers and exporters. The traders make significant gains (losses) when the underlying currency value fluctuates in a large band. For example – the value of Indian rupee dropped between June 2011 and June 2012 twenty five percent in value. Further between May and August 2013, the rupee value fell by nearly 23 percent. Currently it has appreciated nearly 9 percent since august 28 low. The importers and exporters are thoroughly flabbergasted with this size of fluctuation. What then is the cause of this fluctuation? Is it possible to prevent it? How will the FII react to this volatility? How do we ensure this volatility is replaced by stability and what is the effect of tapering QE 3 in the US.
Currently our foreign reserves are around $275 billion a sizeable sum of money enough to meet the 6 -7 months of imports. But we need to look at this number rather carefully before me make any judgement about its adequacy to meet the import bills. The amount of FII’s investment is around $ 176 billion of these reserves. The FII’s have invested in the Indian stock and bond market to gain a rate of return, adjusted for currency value change, much higher than what they would make in their home country. FII’s are counting on continuous economic growth as corporate profit is closely linked to the economy growth rate. All predictions for GDP growth rate is around 5%. While this looks sufficient is it the recipe for future FII inflows? We are not sure about it since the money may leave our shores for a host of reasons including their economy’s performance, tax law changes etc. So this definitely is not easily predictable. Indian rupee should not fluctuate widely either because FII’s are coming in or moving out. Unfortunately this seems to be true.
Currently we are enjoying reasonable stability, this of course is not guaranteed. Currently the import oil bill is not paid from the oil companies buying dollars in the open market. Sooner or later they need to replenish the dollars they have borrowed from RBI. Along with this is the special deal through FCNR (B) which already brought $13 billion this year and this is suppose to end in November 2013. When both these schemes come to an end, the deal situation regarding the future of Indian rupee will be revealed. Currently the FII’s are having field day with the sensex breaching 21000 comfortably. This optimism is partly due to the realisation that RBI will stand behind the rupee and support it at the current level – will they remains to be seen? RBI is looking for CAD of $70 billion for the FY 2013 -14 after it touched $ 88 billion in FY 2012 -13
Finally the future of Indian rupee will heavily depend on when the tapering of QE 3 takes place. A sheer warning in June 2013 created big volatility in the value of the rupee. No one can predict as to how much the tapering will be. Best thing is to wait and see. For long term investor selling the rupee short in spite of its fluctuation will be the only meaningful strategy. Intervention by RBI will soon lose its purpose and the true reality will unfold. Lower rupee has its own blessings like possible improved exports and if indeed exports takes off rupee will recover from its lows and stability will return.