For traditional jewellers, their stock of gold often acts as a natural hedge against the depreciation of the rupee. When the currency is depreciating, the cost of importing gold keeps going up. At the same time, the price of the gold stocked with the jeweller also goes up. Sale of this stock compensates the jeweller for his costlier imports.But the situation has turned trickier this year. Since January, the rupee has slid by more than 15%, but gold prices have also fluctuated.Take the Kerala-based Malabar Group, which claims to be among the top five jewellers in the world, with plans to spend $1 billion on an India-wide expansion. This will mean more manufacturing and gold imports. Asher Ottamoochikkal, the managing director for India, says the group has now started considering using hedging instruments. “We have always believed in our gold assets being a natural hedge. But now we are considering hedging and consulting EY,” Asher told ET Magazine last week.
The jeweller’s dilemma is not an isolated one. At a time when no one is sure if the rupee would move north or south, businessmen are holding their breath. Pramod Menon, group CFO of RPG Group, says: “Such a sharp correction has caught us all slightly off guard.” The group has a diverse set of businesses. Some like software and engineering services are net exporters and others like tyres are import dependent.Part of the problem is strong imports. India imports 100 tonnes of gold every month and $5 billion worth of electronics, among others. The government has raised duties to try and reduce imports and the demand for dollars, hoping to stabilise the rupee. But it will be hard to make the aspirational middle-class kick its consumption habit — especially as it has been a growth driver.There seems to be a general consensus among economists that the rupee should settle around 71-72 to a dollar and demand would temper in the face of higher prices of imports. As the rupee falls, exports will also rise. However, this will take three to four months to play out. New export deals will have to be struck. Meanwhile, rupee speculators will rule the roost and business will have to navigate the tricky landscape.Koushik Chatterjee, group CFO and executive director of Tata Steel, says these are new realities that require new strategies. “Given the volatility of the currency, it would be important for companies to review their hedging and currency management strategy to align with the new realities, and adopt a prudent strategy to protect the underlying during these times.”
The real concern is volatility. No one, apart from chest thumping politicians, wants the rupee back at 63-66 to a dollar ( January 2018 rate). And with the Reserve Bank of India (RBI) sitting on forex reserves in excess of $400 billion, there is confidence in long-term stability.One way to find the appropriate level the rupee should seek now is a measure called the Real Effective Exchange Rate, which matches a currency against a basket of three dozen currencies to try and estimate its real worth. The rupee was at 123 on that scale when it was at 66-67 to a dollar, and has come down to 110 now (100 being presumed the real value). Does that mean it has to fall farther from its current level to match 100 on the REER scale? Not necessarily, experts say. “The REER is always a little high for currencies in economies that import more than they export and attract capital at the same time,” says B Prasanna, head of global markets group at ICICI Bank.Chatterjee of Tata Steel adds: “A trending depreciation of the currency in line with the REER, along with a stronger domestic economy, will make the country more competitive.”
Capital flows, however, can be a double-edged sword. Inflows can provide stability in an economy with a current account deficit (higher imports than exports), and a capital flight creates volatility.A herd mentality sets in when foreign institutional investors start leaving a country, says professor of economics at New York University Debraj Ray. In 2013, Ray had written a piece on capital flight, urging the government to stay its course on the food security bill. “India runs a trade deficit. So, overall balance is achieved by sizeable inflows of foreign currency into say, portfolio investment. When those funds flee, you can have large and sudden falls in the currency,” he told ET Magazine over email.Ray says such flight of capital, in an irrational herd, may be triggered by economic fundamentals themselves. “But the sudden alarming movements in the markets are almost always driven by the herding mentality as a result of fundamental issues.” It could be the tightening of monetary policy abroad or the perception that a US-China trade war could have negative spillovers.While there is little control over hot money — foreign portfolio capital flows into equities, funds or government bonds that pull out immediately on global cues — there may be a case for acting against speculators. Renowned economist and former chief statistician of India Pranob Sen advocates a strongarm approach from the government or the apex bank to rein in rupee speculators. He also wants measures to attract dollars (see interview). The RBI should peg the value of the rupee in the early seventies and support it at that level with its reserves, says Sen, so that it sends a signal to speculators.The RBI has another tool to stabilise the rupee and attract more dollars — the interest rate hike — something it refrained from using in the October monetary policy review, on the premise that inflation will be below 5%. Prasanna of ICICI Bank says if crude oil prices reach $100, the domestic currency will drop further. This will lead to faster inflation, forcing the RBI to hike rates. A 5% drop in the rupee means a 20 basis point jump in the Consumer Price Index, Prasanna goes on to explain. A $10 jump in the price of crude oil means a 30 basis point jump in the Consumer Price Index. Together, that is half a percentage point change in the retail inflation index. This should be enough to make the RBI raise rates. While the RBI is only using its reserves to manage volatility, without pegging the rupee at any level, the government has moved ahead with import duty hikes on a range of items. Some of these actions have affected certain businesses, leading to a shift in their hedging strategies.Vivek Sharma, the managing director of Anchor Panasonic, the subsidiary of Panasonic of Japan, says the sudden imposition of anti-dumping duty on solar panels and solar photo voltaic cells almost made its solar power unit assembling business in India uneconomic. Anchor Panasonic imports more than it exports and it manages its currency risk with the help of its parent. “Every quarter, we crosscheck with the parent company in Japan how currency inflation will affect us. We fine-tune our sales target accordingly. So when the rupee is falling, we increase our sales targets to offset the fall,” Sharma explains.The import-dependent edible oil business has been relatively better off. A sharp increase in domestic production has prices in check, as imports became costlier. Sandeep Bajoria, CEO of oil trading firm Sunvin Group, says domestic production rose from 85 lakh tonnes last year to 115 lakh tonnes this year, cushioning the higher import cost.Jewellery retailers, says Surendra Mehta of Indian Bullion and Jewellers Association, try to replenish their stock every evening to make sure they get the current price of gold. If they are not able to get fresh stock, they try to take up positions on gold on commodity exchanges to protect their interest.A lower rupee helps the software services industry. Tata Consultancy Services will see its earnings go up — but so will dollar-denominated salaries. The IT sector giant on Thursday said its second quarter profit was up 22%. Responding to a query from ET Magazine, Managing Director Rajesh Gopinathan says: “Our pricing strategy is benchmarked to inflation. This movement of the rupee is in the expected direction, in line with inflation. We would need to worry only if the currency started moving in the opposite direction to inflation.”Metals, too, benefit when the rupee falls, especially if the prices in India are linked to international benchmarks. Chatterjee of Tata Steel says: “In a depreciating environment, one would keep positions open. However, if it is the reverse, then the business would have to typically increase the hedge ratio of the book. Similarly, for companies with large foreign currency debt that needs to be serviced by rupee earnings. For companies with debt in overseas balance sheet with foreign currency revenues, the risk will be primarily translation without cash flow impact. Fundamentally if the currency movement creates cash impact, then the hedge ratio will have to be reviewed.”Govt must signal it is ready to hurt speculators: Pronab SenEconomist Pronab Sen was the first chief statistician of India and was also the head of the National Statistical Commission. He was a Planning Commission member and was the secretary of the ministry of statistics and programme implementation. He has seen from close quarters government action against a falling rupee, in 2013. Currently the country director for International Growth Centre’s India Programme, Sen talks to Suman Layak about the rupee’s sudden depreciation and how it compares with the 2013 situation. Edited Excerpts:How do you see the depreciation of the rupee now compared with 2013? Was the flight of capital the trigger both times?Whenever there is a current account deficit, and liquid capital flows out, this kind of currency depreciation will happen. The adjustment starts and imports start to go down. It takes three to four months to play out. Essentially, we have to wait it out. However, you will have speculators coming in and pushing the currency down further. That happened in 2013 as well. The government now has to give a signal that it is ready to hurt speculators to make the rupee appreciate. In 2013, it was done through the FCNR swap. The currency shot up and speculators were forced to unwind their positions.What do you feel the government or the RBI should do now?Well, this time, we have reserves of $400 billion, which we did not in 2013. We do not need an FCNR swap. The RBI should say enough is enough, and indicate that it will find ways to get more dollars in. It should tell speculators betting on a further fall of the rupee that we will find a way to reverse the trend and if you hold on to your positions for too long, you will be hurt.There is a view that the rupee had to depreciate, as inflation in India has been higher compared with other markets, while the currency held steady for three years.All of us have done those calculations. I was not particularly worried when the rupee was around 72 to a dollar. Now it has gone to 74. You must note that the stock market crash is also related to the rupee. For speculators, the dollar is another asset, and to buy it you have to liquidate other assets. Clearly, money is moving from equities to the dollar. In 2013, however, we were jittery about our forex reserves. Crude oil was at $110. So the government reacted differently. This time we do not have that kind of urgency.
Read more: economictimes.indiatimes.com