What Does The Rupee's Fall To 88 Against The Dollar Mean For Your Investments?

The rupee's recent depreciation has captured everyone's attention. Banks have reduced trading positions, and importers with large unhedged positions are feeling the pinch. Corporates that engaged in forex derivative deals, hoping for a stable rupee, now hope it doesn't breach 89. The market is abuzz with speculation about whether the Reserve Bank of India (RBI) will allow further depreciation to aid exporters affected by US tariffs.

Haresh Desai, a seasoned market expert and founder of Rajwade Treasury Consultants, noted that the RBI's stance on rupee depreciation will be crucial. With exports expected to decline slightly, pressure on the rupee may persist unless the US tariff issue is swiftly resolved. Inflation isn't an immediate concern, so many believe the RBI might not intervene aggressively by selling dollars.

Impact of US Economic Data

A significant event this week is the release of the US non-farm payroll report on September 5. If this economic indicator is revised downwards, it could boost hopes for a US interest rate cut, potentially supporting the rupee. A senior banker mentioned that in August 2024, the revised number was lower than initially reported, and traders are keen to see if this trend continues.

Samir Lodha, MD of QuantArt and a former banker, suggested that the rupee's slip past 88 might be due to the RBI stepping back. He believes that if left entirely to market forces, these levels would have been reached earlier. This indicates a possible decision to let the rupee weaken further. However, he cautioned that unexpected news could quickly reverse this trend.

RBI's Approach Under New Leadership

Under RBI Governor Sanjay Malhotra, the rupee has shown more flexibility, dropping over 3.3% since March when it was at 85.47 against the dollar. Previously, under Governor Shaktikanta Das, there was a belief that the currency would remain within a narrow range. This assumption influenced derivative deals by importers aimed at reducing dollar purchase costs.

The weakening rupee could benefit export competitiveness and help generate a substantial RBI surplus and dividend payout to the government next year. This comes as fiscal pressures are anticipated to rise due to increased salaries and pensions for central government employees following the 8th Pay Commission and reduced GST rates.

Challenges with Derivative Products

Many corporate treasuries have underestimated potential rupee volatility despite clear signs of upcoming challenges. Desai highlighted that net importers and foreign currency borrowers might face turbulent times ahead. Some corporate treasuries using "Seagull" derivatives as hedges could incur significant losses due to mark-to-market valuation changes.

The 'Seagull' derivative involves buying a call option at a lower strike price while selling another call at a higher price and selling a put option at yet another price. Importers' gains diminish once market rates exceed their sold call strike price—often above 88. Lodha emphasized that while seagulls and call spreads can be effective when managed well, companies ignoring rupee weakness risk losses.

This situation presents challenges for businesses relying on stable exchange rates for planning and budgeting purposes. As uncertainty looms over global trade dynamics and economic policies, companies must remain vigilant in managing their forex exposures effectively.