The rupee has begun 2012 on a note that suggests there will be as many trading opportunities as in 2011. In the first five weeks, the rupee gained eight-nine per cent against the dollar, euro, sterling and yen. It's moved from a low of nearly Rs 54/ dollar to a recent high of Rs 48.6. At an average futures leverage of 50:1 that's tasty for any trader who got the trend right.
The correlation of rupee's gyrations with foreign institutional investors (FII) attitude is apparent. In that same five-week period, portfolio investors made net buys of $3 billion of Indian equity and also bought $3.4 billion of rupee debt, mostly treasury bills. If foreigners stay positive on India, the inflows could push the rupee up even further, to test resistance at Rs 46.5.
Several situations could affect the current uptrend. One is a collapse in the euro zone if Greece defaults or there is trouble in Spain, France, Portugal, Italy, etc. That would probably lead to the dollar hardening versus the euro, as investors flee to the safety of US treasury bills. The rupee would weaken against the dollar but strengthen versus the euro.
Another interesting situation could arise if India's forex-denominated corporate debt such as ECBs and FCCBs require refinancing and redemption in rupees. This would probably drive the rupee down again if there is major redemption pressure.
A third scenario would be a reversal of the Reserve Bank of India's (RBI's) tight monetary policy. If RBI does cut interest rates, the first logical effect should be the rupee weakening, as the rate-differential between the rupee and hard-currency regimes narrows. Right now, Indian treasuries yield around four times as US T-Bills and twice as much as Chinese bonds.
Rupee rate cuts would be good for the corporate sector and cuts may induce FIIs to invest more heavily in Indian assets. I think the correlation between FII flows and rupee exchange rates is stronger than the correlation of rupee movements with respect to interest rate parity. Of course, I could be entirely wrong.
In early January, Bloomberg said two forecasters, with the most accurate records in 2011, suggested the rupee will be at somewhere between Rs 50.5 to 51/dollar by December 2012. Those estimates may have changed, given what happened in the next four weeks.
Technically, the dollar/rupee looks set to see a reaction from Rs 48.7 till around the Rs 50.5 level. It's already moved down to Rs 49.4. This would imply some more FII selling. If you decide to play that move by going long the dollar/rupee, set a stop-loss at around Rs 49.
The author is a technical and equity analyst