Invest in stocks of export-oriented and capital-intensive companies, says Devangshu Datta.
Illustration: Uttam Ghosh/Rediff.com.
The dollar-rupee trade is likely to keep traders interested through December. Major fluctuations can be expected in interest rates and bond yields of both currencies. The market has to discount a lot of information and expectations.
The dollar is going up. In fact, every major emerging market currency has lost ground against the dollar and so has the yen. The rupee has also gone down. Indian markets are trying to adjust for demonetisation. A lot of traders are betting that this trend of a stronger dollar will last through the next few months.
Since early November, the rupee has lost about two per cent against the dollar and also lost ground against the British pound. But, it has gained a little versus the yen and the euro. In hawala trades, the rupee has lost much more ground against every hard currency. The differential between hawala and legal rates will ease off once the window for old currency deposits closes down.
Election rhetoric aside, the US economy has been growing steadily. The Federal Reserve was considering a rate hike in December. And, it is almost certain to hike now that Donald Trump has won the election. He is expected to impose protectionist measures and “bring jobs back”.
Rhetoric aside again, US employment is at a multi-year high. Dissatisfaction among lower income groups is visible because much of that employment is available only at close-to-minimum wages. So, there is reason to expect wage inflation. The extra costs will be passed on and US inflation could accelerate. Dollar bond yields have already started rising in anticipation.
The Reserve Bank of India is in a different situation. Inflation appears under control and the short-term effect of demonetisation will be a recession or severely curtailed growth for several months. At the same time, banks have received huge deposits. The answer must be to cut rates by large amounts to create stimulus. This is likely to happen in December and RBI will also have finished its reverse-swap of $26 billion of FCNR by then.
Interest rate differentials between dollar and rupee instruments would narrow, if the repo rate (currently at 6.25 per cent) is cut and the US Fed Funds Target rate (now at a range of 0.25 per cent to 0.5 per cent) rises. As the differential narrows between the policy rates, rupee assets become less attractive for foreign institutional investors (FIIs). The currency risk will rise, while the excess return from rupee assets will drop.
If FII selling continues, the dollar will rise even more, setting up a feedback loop, where more FII selling will occur.
The bond markets are also signalling a narrowing. The US 10-year treasury bill is trading at around 2.3 per cent now, having risen since the election. The Indian 10-year treasury yield has dropped to almost exactly match the repo rate at 6.25 per cent and has even dropped lower than the repo, intra-day. In fact, Indian T-bill yields are at multi-year lows, while US T-bill yields are at multi-year highs. As the spread narrows, the dollar will tend to rise.
There are ways to try to exploit the trends of a lower rupee and lower rates if these do occur. The most risky method is to enter the extremely leveraged currency derivatives markets, where the trader can buy dollar-rupee futures. The trader who does this could make (or lose) a packet.
Another method is to buy the shares of exporters. Exports will receive some competitive push if the rupee gets comparatively cheaper than the dollar and other emerging market currencies. Even non-US exports tend to be dollar-denominated. So, rupee weakness versus dollar is a definite edge.
The problem here is that exports aren’t doing well and given threats of US protectionism, there is nervousness in the information technology sector, for example. However, valuations of exporters have fallen. So, this could be a long-term opportunity.
A third method is to focus on rupee debt and ignore dollar-rupee fluctuations. Consider buying into a basket of debt funds. As rupee interest rates fall, debt funds should make capital gains. Some have given capital gains of over 20 per cent in the past two years. That beats equity returns hollow over the same period. Indian commercial interest rates will also fall. This means capital-intensive businesses will gain.
But, recessive conditions will lead to more rate cuts and more cash coming back into circulation before the business cycle turns up.
