Shake, Rattle, And Roll

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It seems to be quite ironical that when there is a crisis in Indian economy, the rupee usually slumps and the same thing happens when there's a crisis in the US economy. Why is it that the decline is so affected? This seemingly interesting fact is a glaring reality in our case and was put on display when the Lehman-Merrill tumble led to a global financial knot last week and the rupee fell to a two-year low of Rs 47 to a dollar. So much so that a panic-stricken RBI had to intervene to boost both liquidity and confidence. If experts are to be believed then this crisis is far from over and this could have many dimensions waiting to be unfolded.

The basic reason why the rupee got most of the beating is that a majority of the external investment, which has been running the show of the Indian economy for the past few years, has its base in the US. Considering that the US is the world's most powerful economy, any fire that is sparked off in its backyard is sure to singe operations in India. The rupee is an indicator of the heat that is generated in any such critical situation. "We can't see the rupee in isolation and as the FIIs inflows dry up the impact on Indian economy will increase in the coming few days and we can say with certainty that the clouds of the present crisis haven't blown over yet," says Dr Devi Singh, former Director, Indian Institute of Management (IIM), Lucknow.

Though the rupee gained some momentum on September 19 and then again on September 22 on account of some positive signals from the US government that announced a package to limit the omnipotent financial crisis, this gain was but restricted by the poor showing in the stock market when the closing bell rang out on September 22.The rupee immediately shed some of the gains it accumulated over the past two trading days. An important factor though is that over a period of two good days, the rupee strengthened by almost 2.44 per cent (1 per cent on September 22 and 1.44 per cent on September 19) to touch Rs 45.355 per dollar at the opening on September 22. This was the biggest gain achieved over the past two decades. However, it's too early to raise a toast considering that the rupee has slumped to a new low of Rs 46.71 to a dollar over the last two years and is lower by more than 18 per cent if compared to its January rate of Rs 39.42 per dollar.

The main reason for this decline is the persistent selling done by FIIs in the markets in the last couple of days, owing to the crisis in their parental counterpart in the US. According to SEBI data for the month of September, FIIs were net sellers of Rs 6,168.90 crore till September 19 leading to a liquidity crunch in the domestic market. This situation comes across as being quite fearful when we study the FIIs' activity in 2008. Since January, FIIs have sold shares worth Rs 34,940.30 crore in comparison to the purchase of around Rs 70,000 crore made in 2007. This in itself speaks for the situation of shortage in liquidity.[PAGE BREAK]

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Now the scenario is that due to the crisis in the US, FIIs are pitching in for hefty selling in the Indian market. They receive rupees in the form of payment but need dollars to remit funds to their US counterparts. And that is why these institutions have indulged in heavy purchasing of dollars from the domestic market. "On the one hand FIIs are selling like there was no tomorrow and on the other hand, the financial crisis has been drying up the inflows, thereby putting pressure on the rupee," explains Dr Devi Singh.

Due to the generation of this alarming situation, the RBI immediately swung into action on September 16 as the overnight call rate had reached to 16 per cent and fired some soothing salvos to increase the supply of dollars in the market and decrease the cost at which the banks have been borrowing money. When the call rate hovers around 6 per cent it sends a signal of there being ample cash in the market. Meanwhile, the RBI also increased the maximum limit of the NRI deposit rate by 50 basis points and augmented the dollar supply by selling dollars in the open market through its agent banks in a bid to push up liquidity. Additionally, leniency has been allowed to the banks in terms of borrowing from the apex bank to give them ample support, thus leading to an indirect cut in the statutory liquidity reserve.

Another factor which seems worth noting in reference to the rupee's health is the status of the currency future in the country. The currency future trading started only on August 29 with the reference rate being Rs 43.73 per dollar. But experts believe that with increasing activity on this front there could be a reason for the decline of the rupee since in a period of only 20 days the rupee depreciated by more than 6 per cent. This assumes significance if we compare this with the depreciation rate over the past eight months.

Since January 1, the rupee depreciated just 11.7 per cent till August. Experts are of the opinion that due to more activity on the future trading front more people can now take part in the currency market and as the instability in the global market is enormous, people are eyeing this as an opportunity to earn quick bucks.

The other reason that has been pushing the rupee into a tight corner is the bearish mood of Indian markets since there are no fresh purchases happening here. The rupee in the last couple of sessions has been stumbling in the wake of a gloomy stock market, unable therefore to shed off its sickness. This is exactly what happened on September 15 when due to a sharp decline in the stock market the rupee was knocked down to Rs 46per dollar due to worries about global financial sector problems. There is anamazing level of bearishness in the market and as of now there is no expectation of any dollar inflow to provide the necessary boost.