The Indian Rupee is a monster versus the US Dollar

The Indian rupee gained to its strongest against the dollar in 10 months yesterday as banks sold dollars to meet funding needs amid a cash squeeze that has pushed the call money rate to six-year highs this week.
Dealers said capital inflows into local equities and the absence of central bank intervention to cap the rupee had prompted some dealers to sell the dollar aggressively.
The partially convertible rupee ended 0.11 per cent up at 44.25/44.26 per dollar after climbing as far as 44.22/44.23 – its highest since mid-February.
“The typical end-of-month importer demand seems to have abated for the moment. Also capital inflows are strong and that is pushing the rupee higher,” said R.K. Gurumurthy, chief currency trader at ING Vysya Bank.
Foreign funds have bought more than $8 billion worth of Indian equities this year.
Further, the rupee’s yield attraction had increased after the central bank said it would increase the cash reserve requirement (CRR) for local banks, which has tightened the supply of cash and pushed up market rates.
The overnight money market rate hit 13 per cent on Wednesday – its highest since September 2000 and well above the central bank’s overnight lending rate of 7.25 per cent – and was around 12 to 12.5 per cent yesterday.
“There was some concern the Reserve Bank of India may intervene to stem the rupee’s sharp rise but that hasn’t happened so far, as that would blunt the CRR hike objective,” said a senior trader at a foreign bank.”
The central bank intervenes to protect the rupee’s export competitiveness against other currencies or curb volatility.
But the intervention also adds to the supply of rupees in the market, which effectively loosens monetary policy.
According to a JP Morgan index, the rupee is overvalued by more than 8 per cent compared to about 7 per cent in the month-ago period.
“Strong inflows supported by a largely optimistic sentiment towards emerging markets should push dollar/rupee lower, though central bank operations to curb volatility and check valuations might result in limited upside for the rupee,” said a recent JP Morgan report.


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India is eyeing a home-grown rupee futures contract to rival a market that opened in Dubai this month, but policymakers are expected to move slowly because of major hurdles to trading.

The central bank has come under pressure to allow rupee futures trading since Dubai listed a non-deliverable contract that settles in US dollars.

In addition, the fast expanding foreign exchange rupee market suggests underlying demand.

But there are big obstacles, including a currency that is not fully convertible and the central bank's dislike of speculators, seen by many as key to ensuring a vibrant market.

"If you want a very liquid derivative market and you think there should be no speculation, it is not possible," said PH Ravikumar, managing director at NCDEX.

"If you want to cook rice, you need water.

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India's foreign exchange market has expanded rapidly in recent years alongside India's soaring economic growth.

Annual gross turnover of foreign exchange was around $6.5 trillion in the year to the end of this March, up from $1.4 trillion six years earlier.

The rupee has gained 15 per cent against the dollar from a three-year low last July and is now trading at its highest levels in nine years.

Hedging

The country's two largest software exporters - Tata Consultancy Services Ltd and Infosys Technologies Ltd - said in May they are increasing their hedging to cushion earnings from foreign exchange risks.

"Any economy needs an effective hedging instrument and clearly currency futures represent such an instrument," National Stock Exchange president Ravi Narain said.

"If you ask whether currency futures are desirable, it is a resounding 'yes'."

Indian companies can currently hedge using over-the-counter currency options, swaps and forwards, but turnover is small partly because of the capital account restrictions for the rupee.

The Dubai market was set up to tap growing trade between India and the United Arab Emirates, India's third-largest trading partner.

Traders in Dubai say the market (DGCX) is dominated by rich individuals, rather than banks or companies.

Although they described trading volume as healthy, the market, with seven contracts reaching out to June 2008, had open interest of just 74 contracts on Friday.

Still, Indian policymakers are being prodded to follow suit as part of a broader opening up of the economy.

"The more such kinds of products exist outside India, the more anomalous it seems that India does not have any such kind of product," said Shahab Jalinoos, currency strategist at ABN Amro in Singapore.

India's Financial Express newspaper said the opening of a rupee futures market in Dubai symbolised "the profound mistakes of Indian economic policy", a reference to the slow pace of economic liberalisation.

The rupee has been convertible on the current account, which covers trade expenses, since 1994. But it cannot be exchanged freely for foreign currency for acquiring assets overseas like shares or property although the central bank is working on this.

Convertibility

A so-called convertibility panel produced a plan last September for increased convertibility of the rupee by 2011. That includes a rupee futures market, although the central bank only set up a working group to look at the idea this April.

"As far as currency liberalisation is concerned the central bank has been fairly conservative and it will take a cautious approach rather than rushing into it," said Madan Sabnavis, chief economist at the National Commodity and Derivatives Exchange.

The central bank bans speculation, or positions taken without an underlying exposure to the currency, in forwards markets.

A similar rule could strangle a futures contract so the central bank may have to be more lenient towards speculators, analysts said.

India's commodity and stock exchanges are lining up to offer rupee futures, but are regulated by different authorities, making it unclear who could legally operate them given the central bank regulates money markets.

"World over, currency futures are traded on commodities exchanges," said Jignesh Shah, the managing director of Multi Commodity Exchange of India Ltd.

"In India it should ideally be on the commodities exchanges, but it should rather be under the [regulation of the] Reserve Bank of India."

Senior currency traders expect the central bank to take up to a year to draw up concrete plans for a rupee futures contract and would expect foreign exchange heavyweights like Citi-bank, HSBC and JP Morgan to take the lead once the market opens.