Rupee fortune swings on FII mood, volatility in capital flows

With volumes thinning as compared to other currency markets, the rupee-dollar market sways to the whims of the overseas investors as they pull out or flood the domestic markets with capital flows.

Rupee depreciated by 20 per cent in a span of five months, suffering the biggest hit during November-December when it touched a record low of 54.30 per dollar. Since the start of January, though, the Indian currency has been on a recovery mode — mostly as a consequence of concrete measures taken by the Reserve Bank of India (RBI) in past two months.

Historical data also shows how the rupee gradually moved in one direction over a period of time and then the other. For instance, the rupee appreciated by over 16 per cent in 18 months to 39 levels against the greenback in January 2008. However, it was followed by depreciation of over 32 per cent in a much shorter period of time.

TURNING POINTS AT A GLANCE
Date	Rupees  per dollar	Change in %	Period in  months
Jul ‘06	46.88	—	—
Jan ‘08	39.27	-16.23	18
Mar ‘09	51.94	32.26	14
Aug ‘11	44.07	-15.15	29
Dec ‘11	53.72	21.90	4
Jan ‘12	49.45	-7.95	1
(-) indicates appreciation  (+) indicates depreciation Source: Bloomberg

Economists attribute the unidirectional movement of the Indian currency against the greenback to the thinner volume as compared to the other cross currency markets. As per data from the Clearing Corporation of India, the average daily volumes in the forex market were about $20 billion in the month of December 2011.

“The volume in the rupee dollar market is thinner compared to, say, a dollar-euro market,” notes Siddhartha Sanyal, chief India economist, Barclays Capital. “As a result, if a few large corporate bodies, banks or big foreign investors take positions in one direction, that can potentially influence the rupee-dollar exchange rate more than the matured market currency pairs.”

Also, foreign institutional investors (FIIs) in India often tend to move in similar directions at a particular point in time, exerting stronger influence on the exchange rate in the near-term.

On Tuesday, the rupee gained 0.7 per cent to close at 49.45 against the dollar with the help of capital flows from FIIs. According to the Bombay Stock Exchange, there were net inflows of Rs 624.1 crore to the equity markets that ended up by around two per cent.

“High volatility in net capital flows has added to the rupee volatility, since India has a rising current account deficit,” notes Sonal Varma, economist at Nomura. For instance, while October saw net inflows of about Rs 3,000 crore, there were outflows of about the same quantum in the following month. The trend was again reversed in January with net inflows of about Rs 27,000 crore with majority of funds being directed towards the Indian debt market.

“Any big deal struck by a large corporate can have a 20-30 paise impact on the exchange rate,” according to Abhishek Goenka, CEO of India Forex Advisors.

The stern steps RBI took in December were aimed at curbing speculation in the market and attracting fresh flows to the country. “Since RBI instituted stiff guidelines, the market is not attaching much significance to the developments in the euro zone,” says Param Sarma, director and CEO, NSP Treasury Risk Management Services.

The rupee has appreciated by around seven per cent in January, even as the dollar index went from 80.18 to 78.87 and the euro appreciated 1.3 per cent in the same period.

In November, when the rupee fell from 49 to 52 levels, economists at HSBC Global Research had noted the market’s perception of (RBI’s) foreign exchange policy had played an important part in recent rupee weakness.

In a report, they said, “The RBI appeared to be quick to act against rupee weakness in September but was equally quick to rebuild its foreign exchange reserves in October.” They added, “So, this has left the impression that policymakers are willing to accept rupee weakness as a necessary part of the economy’s rebalancing, provided the currency’s weakness from current levels is measured.”