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Why the rupee is marching to it own gloomy beat PDF Print E-mail
Written by George Albert   

Written for First Post
June 23, 2012 - The rupee ignored inter market correlations to the US Dollar and global equities to make new lows against major currencies, despite the Reserve Bank's resolve to stay firm. The price action of the Rupee shows that the long term secular weakness of the INR cannot be solved by RBI alone, let alone a single monetary policy. 

Notice that even though the Rupee slid the stock markets have held steady, despite the so called "disappointing" monetary policy. The INR touched a new low of 57.33 to the US dollar before crawling up to close at 57.06. This week the INR also touched new lows against other major currencies such as the Euro at 71.91, Japanese Yen at 0.7116 and the British Pound at 89.45.

The stock market seems to like the fact the Reserve Bank stood it's ground with one loose end. The NIFTY (See NIFTY chart ) has held above its 50-day and 200-day simple moving averages.The 50-day average is shown by the blue line and the 200-day by the black line. A moving average is the average price over a specified period and tend to act as support or resistance. Since the index is above the average, it's acting as support. Support areas are where demand for stock exceeds supply leading to a rally in price. The NIFTY can rally all the way to the resistance zones marked by the red horizontal lines on the chart. Resistance zones are areas were the supply of stock exceed the demand for stocks leading to a fall in price. 

We feel that the stock market is in a holding pattern with the US Federal Reserve not easing money supply further as some expected and the hope that the European Central Bank might given the trouble in that continent. 

Meanwhile the Rupee is in a terrible spot. Decades of deficit financing and increasing money supply has taken it's toll and cannot be fixed in one monetary policy with no supporting fiscal policy. The Reserve Bank too did some sneaky easing by way of an increase in the limit of export credit refinance of outstanding export credit of banks from 15% to 50%. This can add  Rs. 30,000 crore to the banking system, which is equivalent to a 50 bps cut in CRR.

Reserve Bank's  quiet easing is similar to giving a diabetic sugar free lunch and then sneaking a cup of shrikhand for desert.  

The only thing that determines the price of any asset is demand and supply. The increasing supply of money did contribute to the INR's latest fall. The Reserve Bank did leave interest rates untouched to send a signal that the value of the rupee is as strong as it was before the policy announced. But the markets disagreed: "How can you increase the supply of an asset and keep the price of it at the same level?"

So the markets did the rational thing. It reduced the rate of return on the rupee but devaluing it. To put it simply if an investor held 100 rupees with an interest rate of 10% per annum, he would have got 110 rupees at the end of the year. After the Reserve Bank decided to infuse liquidity but maintained the interest rate the markets the depreciated rupee, he'd perhaps get just 108 rupees. Some you might say this is true only for foreign investors who convert Rupees to foreign currencies when repatriating the money. Not so fast. Indian citizens basing their investments in Rupees will see their value eroded by inflation. 

The fall of the INR looks really terrible when compared to other assets. Let's compare the it to the Dollar index (See Dollar index ) which measures the greenback against six major currencies.  The index began falling from June 1 to June 19 so ideally a weakening dollar should have led to a rally in the Rupee. The Rupee only rallied for a week till June 7 and once it touched 55 against the dollar the depreciation began. The inverse correlation between the US Dollar and the INR failed to work, which indicated an extreme weakness in the Indian currency. 

The Rupee and global equities are both considered risk trades. On June 4 the S&P 500 (See S&P 500 chart ) began to rally to peak last Thursday. However, the Indian Rupee continued its drop. To make matters worse the INR has now made new lows against other major currencies such as the British Pound, Yen and Euro. On Thursday the Euro had a major drop against the Dollar, but  appreciated against the Rupee to new highs. This shows a terrible decimation of the Indian currency.

We all know the reasons for this latest new low for the Rupee -- deficit financing and terrible policy muddle. The multi-year deficit by the Indian government and the willing deficit financing by its partner in crime the Reserve Bank of India has increased money supply to such high levels that the falling rupee is no surprise. There is no quick solution for this problem created over several decades. India has to embark on the path of smaller government, larger private sector and sound money to get over the problem.

Meanwhile in the short term  keep eye on the Dollar index. It seems to be on it's way up to 83.56, which will put more downward pressure on the rupee, unless the RBI intervenes. The 83.56 level is an area of resistance, where the supply of dollars exceed demand, which has led the greenback to fall a few times. If that level is broken the dollar can rally strongly much higher. Rupee bulls should pray that the level holds.

S&P 500 and the dollar