Tom Cleveland

National currencies on a long-term basis tend to fluctuate about a "mean value" over time, as long as cross-border capital flows are managed prudently and monetary policy follows strict and accepted guidelines.  For the past three years, the Indian Rupee has traded within a tight range of from 44 to 53 per the U.S. Dollar, but recent activity has threatened the weak end of this spectrum and caused concern amongst government officials and foreign investors, as well.

Predicting the future path of a national currency is never an easy exercise.  Major forex hedge fund managers experienced one of their worst years on record in 2011, testament to the difficulty involved, especially when market conditions are uncertain at best.  Although there are many variables that are public knowledge, the problem stems from the hidden world of daily capital flows, which are driven by a host of fundamental and psychological considerations.  In this new era of globalization, a slight change in interest rates in one market can cause immediate shifts in investment capital across the globe.

What are the near-term prospects for the Rupee?  Let us begin by drawing insights from the following chart:

The performance histories for the past three months for three key market indices are presented.  Here are a few conclusions that can be drawn from this "snapshot":

• Stocks and bonds are more volatile than currencies;
• The Indian Rupee was closely correlating with global stocks, as represented by the S&P 500 index, but a "de-coupling" occurred in mid-March as interest rates in U.S. Treasury securities spiked up.  The market had expected more quantitative easing by the U.S. central bank, which would have kept interest rates in check, but comments by the Federal Reserve suggested that this might not be the case;
• When the rate spike subsided, capital left the fixed income world and was directed into the stock market, preferably where safety and soundness was an offset for uncertainty;
• Under these circumstances, capital tends to exit developing markets and find "safe havens" until the level of uncertainty is removed from the near-term horizon.

In line with this "predictable" scenario, Indian officials have noted in the press that nearly 8 billion Rupees have been withdrawn from Indian equities by foreign investors during April alone, when net inflows had been the result for the first three months of 2012.  Major capital inflows from global investors have been the rule for the past few years, a reflection of India's growth story and the government's attempt to privatize a number of its nationally owned businesses.  The last major outflow occurred in 2008, resulting in a 52 percent drop in foreign investment and a 25 percent drop in the value of the Rupee.

The Rupee has lost 7 percent of its value since February.  Are more losses on the way?  India's trade deficit has been growing for the past year, more so recently due to a weakening national currency.  India is a leading exporter of jewelry, textiles, engineering goods, and services, but India is also highly dependent on coal and foreign oil imports for its energy needs.  Energy costs have also increased recently, as tensions in the Middle East mounted once again, but oil prices are beginning to decline, a good sign.

Global capital flows can be "fickle" during times of uncertainty, but, eventually, capital must go where the growth is, and the growth engines in Asia are set to respond to improvements in the economic recovery in the United States.  Europe is the primary issue, but a strengthening in the Rupee is inevitable over time.

Tom Cleveland has had an extensive career in the international payments industry with over 30 years of experience in executive management, corporate governance and business development. He served as CFO for various Visa International entities from 1980 until 1999, retiring with the title of Group EVP and Treasurer. Currently, Cleveland writes for forextraders.com and applies his graduate work in Finance at Georgia State University to commentate on various investment topics.