Desperate Measures to Arrest the Rupee’s Slide

I read an article in The Financial Express of yesterday about the measues taken by the RBI and a couple of other agencies to halt the rupee’s decent and constructed the following infographic.

India Controls to Stem Rupee's Slide

The Rupee Squeeze

What an u turn we have seen – of people of all manger of expertise who once extolled the decoupled state of Indian economy during the erstwhile “India Shining” days who are now weighing in with stories of markets being joined at the hip! Local stories do little to educate on what is happening and is going to happen (!) in our local markets. Most local commentators worth their salt correctly look to charts of the SPX, USD, credit in the US etc. as reliable portends of the shape of things to come. The de-couplers of past were certainly wrong – they ignored the big glue that sticks us (and other emerging economies) together with the rest of the birds flying at the head of our skein. That glue, is undoubtedly the currency exchange rate. Take a look at the comparison of the NIFTY vs the DEFTY chart below. I have also charted the ratio of DEFTY over NIFTY – since 1994 each unit of NIFTY is getting you progressively lesser and lesser quantities of DEFTY, indicative of a massive squeeze on the INR.


The human eye searches for patterns where there ought to be none! My untrained eye seems to suggest a great support at 3,000 on the DEFTY. We are ~3,350 currently, so a nice 10% correction would get us there. Possible? I don’t think any expert would be foolhardy enough to put a zero probability for that happening. So, either the INR rises in the immediate term or the market falls on disappointing results or both happen to get the DEFTY down to this level. But yes, as far as patterns and psychological levels of supports go, the 3k mark does provide a nice breather.

Corr Coefficients N day returns vs next N day returnSo if you are trading, the USD:INR is obviously a huge factor to consider. The graph on the right plots the correlations between N day returns (on a given day) and the immediately following Nth day return. The blue line is for the NIFTY N day return correlations while the red line shows this relationship for the DEFTY. For positive value of correlation coefficients, one can expect that given a positive (negative) N day return, the next N day return will also be positive (negative) – i.e. the tendency for the trend to continue. Both the NIFTY and DEFTY data suggests that this correlation peaks at N = 10, implying that given a 10 day trend, it is most likely that the following 10 day period will stay true to that trend. The point here is that from an overseas investor perspective, the relationship is more pronounced as compared to the internal view. NRIs are raking it all in!! Hopefully some of them will fill our reserves with their precious FCY and buy houses here.

Rolling 10 Day Returns NIFTYPlease note – this is median behavior, the N day returns are likely to show a normal distribution with some really fat tails (9/11, bombing of Parliament, Lehman event, etc.). the chart below shows the rolling 10 day return on the NIFTY over time and its 50 period moving average line. The outliers (i.e. the fat tails of the N = 10 day return normal distribution curve) are as high at 26.8% on the positive side and as low as 27.7% on the negative side!! Shouldn’t trading be an Olympic sport?

Petrol on a Roll

Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once unthinkable dosages will almost certainly bring on unwelcome after-effects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation.
Warren Buffet

I did some number crunching and came up with the chart on the right. It shows the movement of the price of a liter of petrol in INR (stepped blue line) vs. it’s price in equivalent dollar terms (red line) over the past 10 years. The price of petrol in equivalent USD terms has always been  higher than the local retail price except during Jan – Feb ’09. Petrol pricing strategy seems to rely on ‘fixing’ the retail price of the fuel so as to minimise the tracking error against the red line. I constructed this chart to test this exact same hypothesis – point being that the red line is indicative of what the Indian refiners have to pay, in USD, for buying crude oil from the international markets. The blue line is obviously indicative of the revenue they get when they sell it to Amar, Akbar and Anthony. So the gap between the red line and blue line essentially indicates the subsidy burden that the Indian economy and therefore what AAA (the three gentlemen above) have to bear via taxes.

Also, between the INR:USD exchange rate and the petrol price, the latter is the dependent variable, i.e. exchange rate causes petrol price policy. This also comes out through the tracking movement of the blue line vis-a-vis the red line in the chart above. I doubt if all get this – many think that recent petrol price hike will help arrest the recent fall of the INR. Well, nothing like that happened today. Most people also think that the RBI can intervene to control the INR. The fact is that the INR fx market is too large for the RBI to control anymore. We are living in very different times from 10 years ago [ref: these excellent articles by Ajay Shah. click here and here].

Now, what’s interesting with this recent hike is that it has happened at a time when the global price of Brent crude has been in a continuous fall since April this year! So India has increased its retail petrol prices despite a near 20% drop in the global price of oil! Reason being that while global crude oil prices fell by 20%, the INR dropped a similar amount in the same time thereby negating any benefits that could have accrued due to a lower oil import bill.

Also wanted to jot down the observation that the quantum of the recent blue line spike (i.e. price hike) is very high indeed. Maybe the Government had anticipated massive opposition to the move and hiked a lot so that they can roll back a partial amount to appease the insulted. Or it could be that Finance Ministry is seeing the INR go down to 60 soon and therefore have announced a one time whopper of an increase. I do not know what’s behind me but my chart certainly points to an anomaly – i.e. the blue line troucing the blue line by such a wide margin – perhaps for the first time in the past 10 years. Whatever be the explanation, the chart makes it quite clear that we live in exceptional times today and that all manner of caution and discretion is advised especially when allocation your capital to your ideas.

Incidentally, I am wondering if I should increase my ‘work from home’ days given that the price of petrol in Hyderabad has risen from 65.15 (16Jan’11) to 80.58 (24May’12) representing a 17% annualized increase. The only two major cities where petrol is more expensive than Hyderabad are Jallandhar (80.68) and Bangalore (81.01). Petrol remains lowest in Goa at 68.51, but even there, as in all Indian cities, beer is cheaper than petrol!! Cheers.


If this is Greece, what lies beneath? WYSINWYG. The one piece of ice that’s been drifting around very closely to this beast is Turkey. They should have included it in the Euro zone when things were good. Now, I doubt if the Turks will ever swim close to this thing. Cold Turkey, really. Incidentally, which is the country with the highest per capita holdings of gold? China? India? Greece? Its Turkey. China & India’s consumption may be high but Turkey’s growth in consumption is staggering – according to the World Gold Council, demand rose by 32.6% in 2011 compared to the previous year. Both their government as well as the people there are worried about the future. So while many emerging counties’ central banks are loading on gold as a hedge against inflation that the US Fed exports out to them, India seems to be a little bit too big to do that. Lots of money will be needed to buy more and more of the expensive gold and that would mean printing INR that’s getting cheaper in value (and therefore more costly to print) by the day. Considering that inflation will not be allowed to rise up any more than what it has in the past given we are soon going to be entering into the election year it looks like a catch 22 to me. Is my logic correct?

Global Commodity Prices and the INR

The $CRB index gives global price levels of a basket of commodities and is an important indicator that is watched to get clues on whats happening. The index has been declining of late and this would certainly seem to benefit countries like India that have a whopping oil (and gold!) import bill. However, the INR seems to be playing spoilsport. Any gains from a drop in global commodity prices seems to be getting undone by a concomitant drop in the INR. I constructed the below chart to figure out the relative movement of the $CRB and the INR:USD exchange rate. The correlation comes to a high -0.75.

Managed Floats

Jeffrey “King of Bonds” Gundlach was the former head of the $12 bn TCW Total Return Bond Fund. His presentations on the state of whats happening around the economic world are eagerly awaited and discussed. You can find his latest message here. I am showing two screens that caught my eye. These are the lines of movement of the Chinese Renminbi (RMB) and the Indian Rupee (INR).

The INR is on a “managed float” path. Successive administrations at the Reserve Bank of India (RBI) have managed to maintain and further this strategy of not pegging the INR to a particular foreign currency at a particular exchange rate. Earlier, the RBI used to intervene in the currency markets (it still tried its hand very recently), but the growth in recent trading volumes on the INR means that RBI’s intervention will lack any meaningful punch going forward. The INR has therefore moved a little bit closer to full float status. 

The RMB, on the other hand is undergoing a lot of makeovers. It was earlier pegged to the USD at a fixed rate and then in 2005 when the peg was lifted, all the pent up pressure got released and an immediate revaluation took place. However, the peg was unofficially brought back due to the onset of the financial crisis. Then, in Jun’10, China’s central bank said that it will increase RMB’s flexibility. Now it is moving to managed float status. HSBC had earlier predicted the RMB to become the 3rd major world reserve currency in 15 years. That’s a lot of time for a few more makeovers.

Risk Management and Inter Bank Dealings

This will be big news in today’s papers (posting around midnight AM) – RBI’s promulgation of capital controls to reign in the currency movement. There is a meeeting there in the RBI today for a review of its monetary, so some more interesting sound bytes should come out. What if they cut the CRR?

And Ajay Shah provides a contra view to RBI’s action. Boy! If I have to pick between the short term bounce up generated by a possible CRR cut and the medium term lower levels of NIFTY as mentioned in Ajay Shah’s post, I’d pick the latter.

BTW, at one point in time yesterday RBI’s legal tender was quoting at 54.29 times a USD! Can’t believe it. Sort term relief for exporters? Only if they prevent losing their margins to local inflation.

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