RBI can do little to control it as attempts to do so may exhaust our forex reserves.
Currency trading takes place in multiple exchanges, across many timezones. The over-the-counter (OTC) or off-exchange trading in forex is huge as well. Almost all the trading is speculative.
But there is of course, the underlying necessity for transnational corporates to hold and convert currencies. Central banks also need to manage their own currencies, and park national reserves.
The liquidity offered by speculation minimises spreads and ensures commercial and national needs are matched efficiently. Sometimes, the speculation also causes problems, especially when opaque OTC positions spiral out of control.
Arguably, India has been far too timid in maintaining currency controls rather than opting to let the rupee float. Policy makers crow that India avoided the 1990s Asian flu and survived the 2008 crisis with fewer scars because of currency controls.
In truth, the chief sufferers from Asian flu have all registered decades of sustained GDP growth at far higher rates than India. That growth has been fuelled by easy access to external capital. On balance, nations like Thailand, Indonesia and Malaysia have gained much more from free float than they’ve lost in currency crisis.
The big advantage of a free float currency is that investors are more comfortable bringing money in. It’s also easy to raise debt anywhere at competitive rates. Of course, it’s easier for a free float country to invest abroad as well.
The disadvantage of free float is unpredictability. If there’s fiscal or monetary imbalances, the currency may get a hammering. It is impossible to control domestic money supply, interest rates, currency exchange rates and capital inflows and outflows, all at the same time. The Reserve Bank of India (RBI) and the finance ministry would have to work a lot harder to handle a free floating rupee.
There are plenty of instruments for currency trading since the rupee is “semi-convertible”. The MCX and NSE both offer rupee-settled futures and options contracts on the JPYINR, EURINR, USDINR, GBPINR. The leverage on the futures is around 50:1 with margins working out at around 2-3 per cent and relatively small lots.
Traders who have used these instruments effectively have made huge sums in the past few years from persistent trends as well as short-term zigzags. The rupee swung from a high of Rs 39.27 / USD in Jan 2008, to a low of Rs 52.06 in March 2009 (that means a 32 per cent rise in a long USDINR contract), back again to a high of Rs 44 in October 2010 (15 per cent USDINR decline) and down now, to a recent record low of Rs 52.70 (19.7 per cent rise).
Each of those moves was a long-term trend. The winning trades would have been a long USDINR, followed by a short USDINR, followed by another long USDINR. Multiply each percentage move by 50 to get a rough idea of the possible gains. The swings of the rupee versus the Yen, GBP and Euro have been somewhat similar.
There are many ways to attempt to get a handle on future rupee direction. Fundamentally, it should depend on relative real interest rates, trade surpluses / deficits, relative soundness of currency, which in turn depends on government debt, relative GDP growth rates etc. Very complex trading models can be developed on this basis.
In practice, there’s also a strong co-relation to FII buy-sell patterns. If the FIIs sell, the dollar rises - this is driven by capital outflow. Again, this insight can be tested by creating either simple or complex trading models.
Technically, the USD seems to have made a strong breakout, moving to a new high versus the INR. A purely technical trader might choose to stay long on the USDINR and keep an initial stop-loss at say, 51.25. Move the stop loss up by 0.5 for every 0.75 upmove.
Nobody can absolutely confidently call the direction. But one thing is for sure. The rupee will continue to face volatility through 2012 and probably, through any foreseeable future. Given the global scenario, every currency will have a lot of inherent volatility.
The RBI has some measure of control over the range it wants to target. But the RBI dare not try to rigidly control the rupee because it could rapidly exhaust the forex reserves if it attempted to do that in the face of a major market trend.
Any trader who can exploit currency trends has a chance of making serious money in any economy, regardless of the macro-economic situation or the stock market direction. In India, with the strong relationship between rupee direction and FII attitude, a smart currency trader could have a powerful hedge against equity volatility as well.
