Run on the Rupee !!!

Hardly a day goes by without a new reason to be gloomy about Rupee and about Indian macro  .  When  mainstream television debates ( not business media)  find what is happening to Rupee “sensational” , it is time to look up and take notice . Not to mention the flooding articles like “ All you wanted to know about Why rupee is falling” , “Ten reasons for the  fall in rupee”  etc that flash day-in and day-out on news channels . Before you continue reading this , here is the caveat : If you are one of those looking for where Rupee is headed next , this is a wrong place to find any such magical answer . But . in this manic mayhem , if you are one who is looking for a crutch to hold on to your sanity , it is unlikely that you will be disappointed .

In markets , every trend starts with a rational trigger , but soon technicals take over . When trend gets hijacked by momentum ( technicals) , reasons or fundamentals rarely hold .  So is the case with the current mayhem in Rupee . Otherwise , how does one explain this dichotomy – If CAD (current account deficit) was the sole reason for free fall in rupee , it should have cracked last year when CAD was much worse with sky-rocketing gold imports ( exceeding 5% of the GDP) . Even the pessimistic forecast for current year is sub-4% on easing  gold imports and on falling demand . So the problem is not so much of CAD per se , but the ability/ visibility  to fund the deficit  . Comfortable flows (FIIs flows) last year kept the rupee artificially high . Now , on fears of receding flows on QE (quantitative easing) tapering ,  funding looks shaky and hence weakening rupee . That explains the  rational  trigger for the initial fall in rupee to 58 odd level in May-June . Beyond that , it is  “technical” that holds the rupee to ransom .

Technicals work in a bizarre way . While the role of punters / speculators are well known in momentum trade , what is invisible , yet more powerful is the lemmings behavior (herd) of other genuine market participants that accentuates the trend and makes it a self fulfilling cycle . Take the case of behavior of genuine exporters / importers in the current rupee fall . Importers rushing in to buy dollars while exporters holding back their dollars , both on fears of further fall in rupee , thus reinforcing the trend ( so is the case with the remittances) . This added with extrapolation noise from financial community , the whole eco-system works towards achieving the next target set by extrapolation experts from the brokerages . That is how an empty trend becomes all consuming and eventually shakes the conviction of even of the long-term fundamentalists . Not to forget that such a lemming behavior is orchestrated globally as can be witnessed by steep fall in all emerging market currencies in the current meltdown . Aggressive speculative bets in NDF market overseas ( Non-Deliverable Forward market where rupee bets are settled in dollars) made things worse . In such a situation , reasons rarely work . That is one of the reasons why most of the RBI’s or Govt’s measures backfired . In fact , these measures created an an opening  for such a similar momentum trade in bond markets where bond yields rose sharply , initially triggered by RBI’s liquidity measures , but later got accelerated by the self-fullfilling cycle of  new investors holding back from debt funds while old investors rushing for redemptions , thus ending in bond market crash.

Such trends do not last for ever  though . Soon it regresses back , yet timing of which can’t be predicted  . But while it lasts , it is painful and takes a toll vide MTM ( notional marked to market) losses on one’s portfolio   . This is not to argue that all is well  for Indian rupee . Of course macro looks murky and on fundamentals , there is nothing much to cheer for rupee . At the same time , on technical factors , current fears are overdone and sharp reversal on some vague triggers can’t be ruled out . Any signs of reversal in FII flows could be one of them , but need not be limited to only that .

Ironically , flows might reverse at the first signs of stability in rupee as foreign investors rush in to capture the rupee upside besides cheap bond and stock prices . Wise investors understand that it is futile to predict the timing of such a turn and instead focus on capitalizing  the opportunities that are thrown both in bond and equity markets on fears of crashing rupee .  If that is a difficult proposition for any one , the least that they should do is  not to  scoot and run ( panic redemptions / exit from either equity or debt funds) , which , needless to say , is suicidal.

Happy Value Investing !!!

ArunaGiri . N


Bond Market Mayhem…

In a sign of deepening crisis  for macro , bond markets crumbled last week chasing investors away from supposedly safer assets like income , bond  and gilt funds as yields spiked across maturities ( bond prices have an inverse relationship with yields)  . Rarely has the street seen such a distress selling in bonds . Last two weeks have been anything but normal for the Indian bond market . Understandably , investors are red faced as their bond portfolios join the list of growing money losers with nothing getting spared except probably fixed deposits . 

While the immediate trigger for such an unusual turbulence in bond market came in the form of liquidity tightening measures from RBI , the deeper cause goes beyond these. Sharp slide in rupee has a major part in this mayhem .  What started as market’s skittish reaction to Fed’s noise on QE tapering  ( Quantitative Easing) triggered a sharp slump in Rupee in subsequent weeks leading eventually to these frightening  measures from RBI with a aim to defend rupee at any cost .

As part of these measures , RBI tightened the liquidity noose further with (1) bank-specific limits for LAF ( Liquidity Adjustment Factor) at 0.5% of the banks deposits  and (2) restrictions on banks flexibility to reserve maintenance ( minimum daily CRR i.e. cash reserve ratio) , thereby impacting bank liquidity severely . These measures , while aimed at curbing volatility in rupee , will increase the overnight rate to 10.25% , transmit the yield pressure across the gilts yield curve with an eventual impact on the lending rates in the economy if sustained .

If these measures stay , they have the potential to puncture the turn-around script that has been the main pull  for the long-India investors over last few months , esp. the long FIIs. The story built around macro cycle turn would be in jeopardy if lending rates move up in response to these measures as it would reverse all the gains that have been achieved by the monetary and fiscal actions over last 12 months to engineer the recovery.  Govt. and RBI of course will be hard pressed to not to lose these gains and hence will make every attempt to reverse the recent liquidity measures at the first sight of stability in the currency . 

If the sharp slump in bond market is anything to go by , market is discounting far worse prospects for the interest rates than the RBI or the Govt. would hope for . Yields across the spectrum have spiked over last three weeks with the accompanying crash in bond prices . 10 year yield which was hovering around 7.3% not long ago have spiked to 8.5% level as of now resulting in about 7 to 8%+ fall in the NAV of gilt funds    . The story is not so different  with other income and bond funds . Given that the market is never fairly valued and it has the fancy to over-shoot and under-shoot , the current slump in bond market can be a wonderful opportunity for long-term debt investors .

Same is the case for equity investors as well . The ongoing nervousness in the broader markets emerging from potential scare of rising interest rates can be selectively used as an opportunity to build bottom-up stock-specific long-term portfolio in a phased manner .

Happy Value Investing !!!