GCC Liquidity: The Main Casualty of the Global Financial Crisis

This Article was originally published in several Arabic and English newspapers including Arabnews.

The Global Financial Crisis (GFC) has impacted world economies including the GCC. However the biggest issue has been the loss of liquidity in stock markets (as measured by value traded). Stock market investing and real estate are two essential pillars that provided occupational engagement to many GCC nationals. The collapse of both of these asset classes means significant contraction in many respects. This article dwells specifically on the issue of stock market liquidity, reviewing measures that can bring back liquidity at least to some extent if not all.

 

From a peak value, traded at over USD 1.6 trillion in 2006, liquidity experienced annual declines of 40% in 2007, 2009 and 2010 each and reached a low of USD 296bn in 2010 only to recover slightly to USD 354 bn in 2011, the first annual increase since 2006. The 2011 value traded is just one-fifth of the all-time peak experienced in 2006. Such a drastic fall led to many brokerage houses closing shop. So far, during the first half of 2012, the value traded has already exceeded that of the full year numbers for 2011 which is somewhat reassuring.

 The relative halting of lending across the region has played a large part in the declining liquidity on the exchanges. According to the Institute of International Finance, around 10% of bank lending goes towards the purchasing of securities while 26% and 10% goes towards real estate and investment companies, which are currently in a state of distress or low growth potential. Consequently, loan growth across the GCC has decelerated sharply since 2009. The average annual growth in loans between 2004 and 2008 was 29%, reaching a high of 38% in 2007. This rate has fallen to low single digits during the periods 2009-2011.

There are several factors which could aid in bringing liquidity back to regional stock markets. Many of these factors deal with creating an environment which is attractive and conducive to investing, both by retail and institutional investors.

There are not many options when it comes to investing in the GCC region; most funds and portfolios deal with plain “vanilla” products like mutual and sector-specific funds. Fixed Income is only now gaining popularity as an investment opportunity, but even then, most investments are held to maturity and little-to-no secondary trading is available on these products.

 A few derivative instruments have been brought to market; Kuwait Financial Centre “Markaz” has operated the Forsa Fund since 2004, which issues Call Options on Kuwaiti listed stocks. Abu Dhabi and Saudi Arabia both started ETF trading on their exchanges in early 2010, though these had little liquidity. Encouraging the development of a regional derivatives market would help support and raise liquidity levels by providing with additional options and instruments, which in turn would allow for more diverse and sophisticated product offerings.

 Given that the majority of investors in the region are retail investors, who are currently in an illiquid or deleveraging state, an increase in institutional investor support would help increase liquidity. This support has generally been provided by Sovereign Wealth Funds like Kuwait Investment Authority, Abu Dhabi Investment Authority and Qatar Investment Authority, in addition to other Government-owned entities (GOEs). According to Markaz, there are around 60 GOEs in the GCC that hold roughly 30% of market cap spread over nearly 180 companies. Saudi Arabia has the highest penetration in its local market, holding 35%, while Kuwait had the least at 13%.

There have been many regulatory developments in the region over the last few years, some as part of a natural maturing of markets while others have been in response to events brought on by the crisis. Regulatory progress and development is seen as a vital component to the restoration of the GCC markets, bringing with it credibility and the attracting of foreign investor interest. The UAE has pushed through a robust Bankruptcy Law which would provide a legal framework for distressed corporates to operate within. Qatar has been actively attempting to raise its Foreign Investor Limits, mainly to satisfy MSCI requirements for upgrading to Emerging Market status, but the move will make the market more attractive to foreigners in general. Furthermore, the Kuwait Capital Market Authority was established with its regulations and bylaws governing the exchange and investment companies.

Ultimately, a return of confidence is what is needed for liquidity to come back. ‘When that will happen?’ is anybody’s guess.

Risk-Based Investment Planning

This article was published in Indiansinkuwait.com on the eve of independence day on 15th August, 2012.

As investors, we are often faced with the situation to deal with our investment options almost on a monthly basis. As a group, we are so varied in terms of age, qualification, salary, and geographical lineage (south India/north India) and this can be seen in our investment habits as well. Regardless of this diversity, frequently all of us approach the question of investment options through the frame of returns. “Can this investment fetch me good returns?” is the question that we ask before we commit money. In many cases, we base our decision based on information gleaned from friends in social meetings. Our investments are also based on our current liquidity position. We invest when we have money and based on what options available at that point in time.

Predominantly our investments shall typically include fixed deposits, gold, real estate and equities (stock market). Sometimes we may loan money to our relatives and friends to help them in their studies or business. Over time, we accumulate a variety of investments. I see two problems in this approach:

1.       Organizing all our investments and regularly following up on how they are performing

2.       Ignoring risk while taking investment decisions

The first point may sound simple but it is not easy and most of us do a poor job of doing it. It is extremely important to organize all your investments in an excel file apart from physically maintaining all important copies. The job does not end with creating an excel file, the key is to update it periodically (at least once in a quarter if not monthly) and finding out the current value of our investments. These investments are made out of our hard earned income and hence it deserves follow up in order to take quick action on those that are losing in value.  A weekend spent on this is worth the time. Like cancer, most of the investment losses can be avoided by spotting it early.

The second problem is more fundamental. All investment opportunities should be categorized based on their risk i.e., High risk, medium risk and low risk. By high risk what I mean here is that the probability of losing all your investment is very high. Medium risk investments may result in loss but not entirely and low risk investments will not result in capital loss at all. However, high risk may also result in high returns while low risk will result in nominal returns and in most cases do not beat the inflation. Typical examples of investments categorized based on risk could be the following:

Low Risk	Gold, Fixed Deposits, Tax-free Government Bonds and Post office savings schemes
Medium Risk	Real Estate, Balanced funds, Corporate Bonds
High Risk	Stocks, Equity funds, Commodities

Opinions may defer on the classification marginally but not so much that a high risk investment can be felt to be a low risk investments. As you can see, in the low risk segment you may not run the risk of losing your investments while in the high risk investments the risk of losing your investments is very high.

Once you have an understanding of this categorization, then comes the key question: How much of my money should I commit to each of the three categories of risk? The answer depends on your age and liquidity requirements. When you are young, you have more time and hence you can afford to take more risk. The reasoning behind this is that even if you lose in value, you have time to ride it out and hope for the recovery. As you approach your retirement, your ability to take risk is reduced and need for liquidity increases. In this stage, you don’t have the luxury of time. Hence, you should initially focus your investments in high risk and gradually reduce it in favor of low risk as you get old. The following chart can illustrate this transition:

For eg., when you are in the age bracket of say 20 to 30 years, your income may be low but your liquidity needs are also low. The amount that you can save every month (after meeting your regular expenses) can be oriented more towards high risk investments like equities. When you move to the next age bracket i.e., 30-40 that is when you need to reduce your allocation towards high risk in favor of low risk. This can happen either by selling your high risk investments (and hopefully you would have made good profits!) and investing them in low risk or by committing your new money more towards low risk than high risk. As you can see from the chart, when you approach your retirement age (typically between 60 and 70) you can see that most of your investments are in low risk income yielding investments since that is the time when you need income to support your retirement. A key opportunity in the medium risk is the real estate. For most people, real estate make up a large part of their total wealth. Buying the first home has sentimental value . Also, one may argue that real estate has no risk since it does not generally depreciate in value. This may be true but most of us buy real estate through mortgage loan running into several years. During this time, interest rate may fluctuate and cause hardships. Also, sometimes if you make a decision to buy a real estate at the peak of the bubble then the price may start stagnating and sometimes fall as well. Hence, it is prudent to consider this as medium risk than low risk. The increased allocation towards low risk as we enter 40’s and 50’s is to make sure that we have enough liquidity to fund the higher education expenses or marriage expenses of our children.

As the saying goes, “Trust in God but lock your car!”, prudent planning and follow up of our savings is key to financial prosperity. It is not enough that we work hard and earn money, it is equally important to save them in an intelligent and organized manner fully realizing the risk behind those investments.

Buy Low, Sell High, But How?

This article was published in The Global Analyst

The greatest investment challenge for any investor is to buy low and sell high. However,. many a times we end up buying high and selling low!

While historical returns can look appealing, the exact timing of your investment can create huge divergence between your returns and historical returns. If your timing is wrong, then a Buy and Hold Strategy can backfire heavily. This is best explained through this chart that shows annual performance of Sensex since 2004. In these 8 years, we had 6 positive years and 2 negative years. If you would have invested Rs.100 at the beginning of 2005, it would be worth Rs. 234 at the end of 2011. On the other hand, if you would have invested Rs.100 at the beginning of 2008, your investment would be worth only Rs.76 now. So, a passive investment approach (what is called Buy and Hold) may yield results based on your market timing.

On the other hand, if you are an active investor trading in the market day in and day out (what is called as high frequency trading), it mostly will be a negative sum game that benefits only the brokers to earn their commissions. Also, it involves heighted level of tension on a daily basis leading to acidity and associated habits.

This article is to present a strategy that can time the market without emotions but based on carefully evaluated rules (through an intense study of the past). I believe such a strategy can generate ‘above ordinary” returns and can live up to our initial expectation of “Buy Low Sell High” ambition. However, it should be noted that there is NO investment strategy that beats a Buy and Hold strategy 100% of the time. It depends on the level of entry and further market movement.

 Before we aspire to “Buy Low, Sell High”, there are some insights from the market that are worth exploring.

1.       All markets frequently go “underwater” and stay there for longer than what you can anticipate.  For eg., if you invested at 100, and your investment value goes down to say 90, technically your investments are termed “under the water”. The problem is, both the depth and the period of time of your investments being under the water cannot be predicted. The Japanese stock market is a great example. The Nikkei Index reached its highest level of 38,915 on 29^th December 1989. The current level is 8,724 (15^th July 2012), after 23 years!

2.       Do we have such episodes in the Indian market? For eg., if you would have invested on 14^th January 2004 when Sensex was at 6,194, you would have gone under the water immediately and you had to wait till 30^th November 2004 before you could level your original investment[1]. You had to wait for 10 agonizing months during which your investments could have dropped by 24% when Sensex reached 4,708 (24^th June 2004). Any investment made around November 2010 is technically still “under the water”. The probability of something going under the water is high during the peak of  bull markets. Once our investments are “under the water”, we take time to accept the fact during which time it goes even deep under the water. For eg., , if you would have invested on Jan-08 when Sensex was at 20,873, you would be under the water till 4^th November 2010 to reach the same level, a staggering period of 34 months(nearly 3 years) during which time your investment value could have gone down by 60% before it recovered. Simply put, you would be staring at a loss of 60% which can be psychologically nerve wrecking. The lowest point during this period was 9^th March 2009, when Sensex hit 8,160. Like how Sensex can zoom from 8,000 levels to 20,000 levels, it can also crash from 20,000 levels to 8,000 levels.

3.       When markets go under the water, we often ride it down fully rather than limit our loss by cashing out at some stage.

4.       Once our investments are “above the water”, our expectation about future profits is unlimited!

5.       Most of our buy/sell points are either determined emotionally or arbitrarily than a careful evaluation of our investment environment. Psychology plays a major role in our market timing. After we make an investment, and if we move into profit zone, we attribute that to our “skill” and not “luck”. However, when we move into loss, first we are in “denial” mode (how can I make a bad investment decision?) and then when we are deep in the red, we “resign” to our fate and do nothing. Again psychology!

The Strategy

This strategy aims to Buy low and Sell High. The strategy is explained through a series of questions:

When to Buy?

The basic idea is to invest only when market is in a “new low” as determined by a reference to a previous high. For eg.,

---

[1] For the sake of simplicity, I am assuming that you invest in a ETF like structure that replicates the broad market.

On 15^th April 2009, Sensex reached 11,284 a new high. You should index this as 100 and keep referencing further moves to this 100. Subsequent to this, the index offered a “new low” on 16^th April at 10,947. Then offered another “new low” on 21^st April when Sensex reached 10,898 and offered another “new low” on 22^nd April when Sensex reached 10,817.  As per the strategy, we will invest at all such points of “new lows”.

Remember, markets can keep going down for a considerable period of time which means that it will offer you many “new lows”. You should then be prepared to invest in every such “new lows”.

How much to invest?

We should start with a defined instalment amount of say Rs.10,000 and increase the investment amount as we encounter further “new lows” tracked by the indexing explained above. The following rules can help:

As you may see, the amount to be invested is based on spotting a new low and also the level where it is spotted. Hence, it is variable and cannot be determined upfront. All you can do is to have some amount locked up in a money market fund to be utilized as and when the model screams a “buy”. As the table indicates, you may end up investing Rs.15 lakhs during the last 3 years, Rs. 24 lakhs during the last 5 year or Rs. 44 lakhs during the last 8.5 years. But there is no way you will know that in advance since you cannot predict how long the markets will fall.

What is the frequency?

By virtue of the strategy, even this cannot be determined upfront. You may have a situation where you will find the need to invest almost on a daily basis or there may be periods where you will not invest for years.

When to Sell?

You will sell when the market reaches back a high from where you started (i.e., 100).  Continuing on our earlier example, while we would have bought on 16^th, 21^st and 22^nd April because it reached “new lows” on these days, we will sell our position on 24^th April when the index reached 11,329 and surpassed earlier new high of 11,284 and reached a “new high”.

How much to sell?

We will sell all the investments that happened during this period at that day’s value.

How intensive is the strategy in terms of implementation?

The strategy involves buying and selling whenever the model screams so. However, we will not know in advance when it will scream. Going by the number of buy and sell activities, we can classify the findings as follows:

The % number of days on which the strategy will force you to act is at the peak 18.5%. In other words, we will have some trading action only on 18.5% of the time while it is 100% if you are a day trader. Hence, it is not too much of a call to act.

How did the Strategy do?

I have tested the concept for several time periods (last 3 years, 5 years, 8 years) and find that the strategy outperforms the buy and hold strategy in the 5 years and 8 years period significantly while it slightly under performs the buy and hold in the 3 years category. Hence, it is worth the time and effort. However, it should be noted that this strategy  might underperform a Buy and Hold strategy in an upward trending bull market.

When does the strategy perform the best?

When the market goes one full cycle i.e., it comes back to a point where it was before. Technically it is called “Peak-Trough-Peak” (PTP). For eg., as stated before the Sensex reached a peak on 9^th Jan 2008 at 20,869 and thereafter fell continuously till 9^th March 2009 to reach 8,160 after which it started climbing back slowly and reached its earlier peak of 20,869 on 4^th November 2010. In other words, if you would have invested in Sensex on 9^th Jan 2008 and exited on 4^th November 2010 (after app 3 years) you would have just got back your money implying nil returns. However, our strategy would have screamed a buy 35 times all through the fall from Jan 2008 to March 2009. As per the investment band, you would have invested a total of Rs. 13.46 lakhs in this period through 35 buy actions with the last buy of Rs.60,000 on 9^th March 2009 when the Sensex was at 8,160. Remember, as per the band, you start off modestly at Rs.10,000 investment and increase your investment value as the market braces new lows. Since after 9^th March 2009, the Sensex did not encounter any new low, there was no buy call till 4^th November 2010 when Sensex touched a new high and the model told you to sell. The sale value would have fetched Rs. 24.4 lakhs implying an IRR of 30.6% against a 0% return on the buy and hold.  Look how active the strategy becomes when the market falls and how inactive the strategy is when the market is rising!

So, what is the difference in terms of investment style?

Concluding Thoughts

As Warren Buffet said (which most of us do not follow), be adventurous when others are fearful and be fearful when others are adventurous. When you follow that advice, you can buy low and sell high. The idea of investing a pre-defined amount at a pre-defined time will expose your investment to market timing risk. On the other hand, the idea of investing when markets are in a free fall and cashing out when markets are in a free rise will make sure that you don’t encounter capital loss. The idea espoused above is just that. Given our limited ability to deal with losses psychologically, I feel such a strategy can be of great help. All it needs is some basic excel skills which all of us possess these days thanks to Microsoft!

Best of luck!

PS: The Author thanks Mr. Madhusoodhanan for data analysis

Steps to making the renminbi international

This article was originally published in Arab Times

Following an earlier article in the Financial Times (FTfm supplement) Wendy Guo  and Samuel Lum at CFA Institute’s Asia Pacific Office  and Mandagolathur Raghu, President of CFA Kuwait CFA review the milestones and challenges of renminbi internationalisation.

What does it take to become an international currency?

An international currency is widely held outside the issuing country and used in transactions not just between nationals and non-nationals, but also between non-nationals. It is a unit of account for invoicing trade, denominating financial transactions and currency pegging. It is a medium of exchange for settlement of transactions, for foreign exchange intervention and central bank swaps. It is also a store of value used for currency substitution, cross-border investment and central bank reserves.

What will China gain from internationalising the renminbi?

A challenge facing China’s policymakers is the capital preservation of its vast foreign exchange reserves, of which some 60 per cent are in US dollar-denominated assets. An internationalised renminbi serving as a reserve currency could help China reduce its US dollar exposure.  It could also help China reduce the implicit “seigniorage” charge it pays to the US, given the US dollar’s privileged status as the leading international reserve currency. Other benefits include reducing foreign exchange risk for Chinese businesses and improving funding efficiency of financial institutions.

What are the main impediments to internationalising the renminbi?

The main impediments include inadequate breadth of the Chinese financial system and limited competition among its financial institutions. China’s capital markets to a large degree remain closed to foreign investors given the relatively small size of the Qualified Foreign Institutional Investor (QFII) and related schemes. It appears unlikely that the Chinese government will give up control of its capital account in the foreseeable future. While full currency convertibility and capital account liberalisation are not prerequisites for internationalisation, more liberalisation is needed for progress to be made.

How far is the renminbi along the road to internationalisation?

China has been a significant fund supplier in bilateral swap agreements that use the renminbi as their currency vehicle under the Ching Mai Initiative. This is a multilateral arrangement established in 2000 among the Association of Southeast Asian nations (Asean) Plus Three countries to provide short-term liquidity to member central banks to counter currency speculation and avoid a repeat of the 1997 Asian financial crisis.  In 2004, more than 30 banks in Hong Kong started offering renminbi deposit-taking, remittances and currency exchange services. In 2007, offshore renminbi-denominated bonds, also known as “dimsum” bonds, were first issued in Hong Kong. In the autumn of 2012, renminbi currency futures trading will start in Hong Kong. Central banks including Malaysia, Nigeria, Chile, Thailand, Brazil and Venezuela, have started to include renminbi in their reserve portfolios. Recently, the quota for the Hong Kong Monetary Authority to invest its reserves in China’s interbank market was doubled. Renminbi internationalisation has progressed to encompass all dimensions from trade invoicing and settlement to investment products to central bank reserves.

How could the renminbi be important to the GCC?

Due to strong oil prices, the GCC has managed to build huge financial reserves during the last decade. These financial reserves are mostly denominated in US dollars since most of the GCC currencies are pegged to it and that the price of oil is denominated in the currency. However, the GCC region should look into diversifying into other currencies. Earlier the Euro seemed to be a good alternative, but given the current crisis it has proved the opposite.  Increasing trade flows between GCC and the East suggest that an important option may include the Chinese renminbi. Also, China can look to engage the rich GCC region along with other Asian countries in its pursuit of its strategic interest to develop renminbi as an international currency.

What are the challenges and the next steps?

Given the size of China’s economy and international trade, rapid increases in the international use of renminbi in trade invoicing and settlement is almost assured though the volume is still minuscule compared with those of the other main world currencies and fees are still relatively high. However, the renminbi’s allocation in central bank reserve portfolios remains insignificant.  One of the Chinese government’s objectives is building up the service infrastructure and renminbi-denominated investment products offered via offshore renminbi centres. China’s commitment to the development of Hong Kong as a key offshore renminbi centre has been enshrined in China’s 12th Five-Year Plan. Offshore renminbi centres, which include London and Singapore, play a critical role as a “firewall” prior to the full liberalisation of the capital markets, exchange rate and capital account in China.

Longer term, renminbi internationalisation and China’s strategic interest in various Asean countries may strengthen economic ties and could shape a de facto renminbi currency bloc among the Asean and Greater China countries. Optimistic analysts have predicted sizable use of the renminbi in trade globally and full convertibility in about five years.

The Rupee on a Roll

The Indian Rupee (INR) is one of the worst performing currencies in the world during 2012 (Table-1). At Rs.55/USD it slid by 5% in 2012 (so far) after sliding down by a  whopping 19% during 2011. The month of May was especially devastating. Since 2000, the current rupee level is the highest ever seen (look at the graph). This has caught everyone by surprise including the RBI.

The following questions emerge out of this:

1.       Why did the rupee depreciate so fast?

2.       How does it affect various people?

3.       What is the further downside and where can it settle? &

4.       What should be the strategy?

Let me try and answer them one by one:

1.     Why did the Rupee depreciate so fast?

Technically rupee depreciates against the dollar when people sell rupee and buy dollars. And when people sell rupees and buy dollars, it results in negative capital flows and leads to downward pressure on the currency (and vice-versa). The following reasons can be explored:

a.       Global Financial Crisis (GFC)

b.      Weak Indian Economy

c.       RBI &

d.      Corporate Debt and Hedge

Global Financial Crisis (GFC)

Ever since the US sub-prime induced Global Financial Crisis hit the world in 2008, things have never looked better for global growth. While US was firefighting the trouble, the Europe crisis started and engulfed the world. The GFC has reduced the global growth and has thus impacted emerging markets that depended on developed world for exports. While initially the impact among currencies was primarily between USD and Euro, it later on spilled over to other currencies including emerging markets.

Result: Investors flee other currencies and take shelter in US Treasuries (the so called safe haven) causing USD to strengthen and other currencies to weaken

Weak Indian Economy

Indian economy, after growing briskly during the last few years, is expected to slow down during 2012 and next. From a growth rate of close to 9%, the forecast now is about 6 to 7%.

Indian economy’s deficit is spiraling out of control. Both the fiscal deficit (expenditure more than income) and current account deficit (imports more than exports at a simple level) are headed for further deterioration during 2012 and next. While the fiscal deficit will hit 5.9% in 2011/12, the current account deficit will touch 3.9% of GDP during the same period. The current account deficit is triggered primarily by trade deficit (Export-Import). Not only our imports exceed exports, but even within the imports the dominance is by oil and gold imports, something very difficult to control. Lack of progress in deficit reduction is causing poor foreign investor confidence which contributes to negative capital flows (meaning foreigners taking their money out of the country). The deficit is a long-term problem especially the fiscal deficit. No matter which government is in place, populist policies will continue as a tool to gain votes and this will ensure that the deficit does not come down. However, if they do not go up, then that itself will be good news.

Also, during the past few years, Indian government has attained notoriety for governance lapses (2G scam, etc) and policy missteps. Revising the IT Act retrospectively from 1962 in order to bring Vodafone to book was a huge blow to the confidence in our legal structure to foreign investors. Also, there were several governance failures that keeps India in the wrong side of the news globally (a good indication is the number of negative articles that appear in The Economist).

Result: Foreign investors exit by selling rupees and buying dollars

RBI

Reserve Bank of India is tasked with ensuring the financial stability of the economy and hence is the sole inventor of the monetary policy. In the past, when currency encountered volatility or undue fluctuations, RBI used its foreign exchange reserves to intervene in the market (through purchase or sale of dollars) and thereby reduce the volatility of the currency. However, this time around, they raised their hand and declared openly their intention not to interfere in preventing the rupee slide. This may be due to limited foreign exchange reserves currently at $267 billion enough to cover only 5.2 months of imports. For China, it amounted to $2,884 billion and represented 21 months of import cover, a far comfortable situation to be in. Hence, we can clearly understand the predicament of RBI to intervene. While RBI has not interfered directly, it has taken several steps to contain the situation:

·         It now requires exporters to repatriate 50% of export earnings placed in special accounts

·         Limits on intraday net open positions of foreign exchange dealers

·         Restricting currency derivatives (to check speculation)

·         Hiking the interest rate on NRI foreign currency deposits as well as rupee deposits

Result: RBI has no arsenal to arrest the slide immediately but is using other indirect means very effectively so far

Corporate Hedge & Debt

Many Finance Managers, while managing their foreign exchange exposure, turned quite easy and relaxed due to continued rupee strength during the last few years especially during 2010 when rupee was averaging say 45 (you don’t need to hedge when rupee is strengthening if you are an importer and vice-versa). They expected this to continue forever and hence did not bother to hedge their currency risk exposures. Also, many of them resorted to foreign currency borrowing mostly in short-term maturities from European banks disregarding the rupee depreciation danger. However, when rupee started falling (much against their expectations) they were caught off guard and ran for cover to hedge their exposure which led to intense buying of dollars leading to its appreciation. Now many short-term corporate debt is coming up for repayment which will also witness more dollar buying adding to the rupee pressure. Also, the ability to rollover the debt will be limited by European banks due to the European crisis.

Result: Companies will have to find dollars to repay their debt and incur loss due to unhedged positions

2.     How does it affect various people?

A rupee weakness affects the following:

·         Importers (as they have to pay more rupees for the same dollar)

·         Economic image of the country (not able to arrest the fall)

·         Existing foreign investors (their investments are worth less now) &

·         Residents (in the form of say high oil price)

On the other hand, it benefits the following:

·         Exporters (as they get more rupees for the same dollar)

·         Non-resident Indians (NRI’s) (as they get more rupees for the same dollar)

3.     What is the further downside and where will it settle?

While domestic weakness in terms of low growth, high deficit, high inflation has contributed to the falling rupee, we should also blame the global financial crisis accentuating the problem for us especially Europe. This has caused many currencies in the world to fall (see Table 1, Brazil) apart from India. RBI is playing a sensible role of not exhausting our foreign exchange reserves and is allowing the market to determine the level of rupee. If required, it could call on SBI to raise external financing from NRI’s like how it did in 1998 and 2000 (remember the Millennium bonds!). However, the days of Rs.45 is gone. Political weakness is expected to continue with weak policy responses on all issues. There is no quick solution to deficit problems and inflation. Hence, on a balance of factors, the rupee may firm to Rs.51 or Rs.52 by the end of 2012 after hovering over the current levels for some time.

4.     What should be the strategy?

Currency and interest rates are the hardest thing to estimate in financial markets. Hence, the best thing would be to hedge and not try and anticipate currency movements. Having said that, the following could be done:

If you are a domestic investor, you should focus on export oriented sectors like IT for investments. They will have a great year ahead.

If you are a non-resident Indian, this probably is the best time to remit money to India. If you have dollar investments, it will be wise to exit the position and remit the money back to India.

If you are a corporate in India with significant foreign exchange exposure (either as importer or exporter), it is time to have some sound hedge in place as currency volatility is only expected to increase than decrease.

Table-1: Currency Performance

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Currency	May-12	YTD	2011	2010	2009	2008	2007	2006
BRAZILIAN REAL	3.9%	6.5%	12.3%	-4.8%	-24.7%	30.0%	-16.7%	-8.6%
RUSSIAN ROUBLE	9.3%	-0.3%	5.3%	0.9%	-0.7%	24.2%	-6.7%	-8.4%
EURO	5.7%	3.3%	3.4%	7.0%	-2.3%	4.3%	-9.5%	-10.3%
UK £	3.6%	-0.9%	0.4%	3.6%	-9.5%	35.8%	-1.3%	-12.1%
JAPANESE YEN	-0.3%	3.4%	-5.2%	-12.6%	2.5%	-18.6%	-6.5%	0.9%
THAI BAHT	3.1%	0.5%	5.0%	-10.0%	-3.9%	16.1%	-15.6%	-13.6%
PAKISTAN RUPEE	1.5%	2.9%	4.9%	1.5%	6.6%	28.5%	1.3%	1.7%
INDIAN RUPEE	5.7%	4.9%	18.6%	-3.7%	-4.5%	23.4%	-10.7%	-1.9%
SINGAPORE $	3.2%	-1.6%	1.1%	-8.7%	-1.7%	-0.8%	-6.0%	-7.8%
CHINESE RENMINBI	0.6%	0.9%	-4.5%	-3.5%	0.0%	-6.6%	-6.4%	-3.2%
Note: Positive sign indicates depreciation and vice-versa Source: Reuters

Note: Positive sign indicates depreciation and vice-versa

PS: The author thanks Madhusoodhanan for data assistance