so far so good

2011 seemed to go on forever; finally its drawing to a close. US continued to be shaky, Europe is falling apart, emerging markets contracted contagion effects and (in addition) India suffers from policy paralysis.  Nature played havoc in the form of Tsunami in Japan, Hurricane Irene and floods in Thailand.

However all is not lost.  

• Occupy wall street is gaining momentum in the US and Anna at home  
• US continues to grow and ends the year on a positive note, bucking mid year forecast and fears of impeding double dip
• US unemployment rate is dropping and consumer confidence is rising 
• Markets feared a spate of municipal / Government default - but none, fortunately
• European Union and Euro have survived (so far) and reportedly 26 of 27 members have agreed to tighten budget controls in an attempt to stem EU's debt crisis
• India inflation is under control and CRR cut may be around the corner 

The table below shows key asset indicators' level - current and last year's closing.  Gold, US treasuries and Dow Jones have seen some safe haven flows, not surprisingly.  India clearly isn't "shining" anymore, at least as far as foreign investors go.  Major currency pairs look to be ending the year almost close to their years' opening level.

 

	Current	31 Dec 2010
USD/INR	53.05	44.70
EUR/USD	1.3070	1.3377
GBP/USD	1.5670	1.5599
USD/JPY	77.78	81.15
DXY (Dollar index)	79.80	79.03
Sensex	15730	20509
Dow	12291	11577
Nikkei	8423	10228
NY Gold	1592	1421
10Y USD T	2.00	3.29
10 Y IND T	8.50	7.92
Call	9.00	6.75
1 yr OIS (In)	7.75	7.12
5 yr OIS (In)	7.00	7.70

Good news is we survived 2011 (well, almost) and better news is 2012 promises to be another action packed year.

May 2012 (Mayan 2012?) mark the start of an exciting, joyous and new era!

Que Sera, Sera

Rupee touched an all time low of 54.30 last week and looked set to continue its downward spiral. Thanks to RBI's (extreme) measures, rupee has had a (temporary) recovery / halt.  In it's recent directive, RBI has dramatically reduced trading limits for banks and corporates and pushed us back to very restrictive currency trading era.  To highlight changes:

(1) USD / INR forwards booked by residents, once cancelled, can't be re booked

(2) Past performance limit is now reduced to 25% of last three years' average or last year's import/export (whichever is higher) and all forwards booked under this facility will be on a deliverable basis.  No exchange gain will be passed on if such contract is cancelled.

(3) All short tenor contracts (cash / tom / spot) by banks will strictly be on deliverable basis.

(4) FIIs will not be allowed to re-book cancelled contracts.  However rollover will be permitted.

(5) NOOPL (Net Overnight Open Position Limit) of all banks has been reduced across the board.  Banks have been directed to ensure that intra-day and daylight open positions are within the approved NOOPL.

As expected, there has been a significant reduction in trading volume.  For now, it looks like RBI has the house in order. However, it is another story that shallow markets will prove to be less efficient and more volatile.  Some of   the most likely implications:

• Companies with genuine hedging needs will be constrained.  Risk management, anyone?
• Offshore markets likely to see more flows as onshore sees more restriction.  Is there an approach to control NDF's impact on onshore market and is there way to control NDF market in itself?
• Curbs not only speculation also liquidity and would increase volatility in the medium to long term.  

In my mind, these measures could do more harm than help, in long run.  

In another move, RBI lifted the cap on interest rates paid by local banks on foreign currency deposits of NRIs.  There has been easing of ECB norms by allowing Micro Finance Institutions (MFIs) and NGOs to access foreign currency loans.  While these measures are aimed at attracting foreign currency flow, how significant and immediate the impact would be, is questionable.  RBI is also said to be toying with the idea of significantly pushing up the cap on all-in cost of overseas borrowing by corporates and also allow companies to borrow more through the ECB route.  

All this is ok but not enough.  Global issues, our own fiscal and economic mess, record debt coming up for repayment (almost double as 5-yr average) in 2012, fleeing foreign investments etc., will continue to weigh on rupee, and our central bank can only do so much.  

It's more to do with Government's behaving like a rabbit caught in the headlight and complete lack of sensible policy measures.  Action - long overdue please!

"Que sera, sera

Whatever will be, will be

The future's not ours, to see

Que sera, sera

what will be, will be...."

sad, but seems like our plight, at least for now.

Currency - news and views

Fed holds rates

In the FOMC meet held yesterday, Fed kept rates unchanged while keeping the door open for further easing if  European turmoil continued thereby increasing downside risks to to the US. Feel good factor is that the economy is expected to expand close to 3%  in it's current quarter; this compares with 2% growth in 3rd quarter and sub 1% growth in the first two quarters of this calendar year. Jobless rate is down, consumer spending looks up and factory activity is higher in the US. On the flip side, November retail sales had its lowest growth in the last five months, unemployment is still at a level that poses concern and housing market is still sluggish; explains why Federal Reserve is in no hurry to tighten rates yet. .  Dollar index moved past 80 reflecting greenback's safe haven status.    US treasury yield is still on the rise with 10 yr currently  at 2%.  

Euro woes

European Summit that ended last weekend agreed on an intergovernmental treaty but nitty gritties are expected to be worked on over the next three months. It is clear that while such summits may try to foster future financial discipline and better fiscal integration, it has no magic solution to save Euro from it's current mess.  Markets remained skeptical as there is no concrete steps to alleviate European government's debt crisis. Proposal to increase EFSF has not been favored by Germany's Merkel and market is jittery ahead of Bond auction today and tomorrow.  Euro is trading close to year's low and expected to continue its trade with a negative bias.

Rupee - how low?

Rupee is dragged by global factors but the pace is being determined by local issues.   Slower growth, disappointing IIP, balance of trade and current account deficit are crippling the economy and currency, but policy paralysis tops of the chart. RBI supplied dollars to cool demand but exporters remained on sideline as most analyst expect the rupee to weaken further. Given this, the supply side has been limited and it is obvious that RBI's intervention is only likely to be a token with its limited firepower.  With EU crisis worsening by the day, capital inflows into emerging markets is suffering a serious setback.  RBI is likely to hold rates in its policy meet on Friday and let's hope for strong policy measure from RBI to curb further fall in Rupee.  While hoping for respite, act based on reality.

(sent out by mail on Wednesday, Dec 14)

Self denial or destruction?

Yet again, proposal of FDI in retail has been shelved.  Well, that's the truth;  however to be politically correct (pun intended), our Finance minister today announced that the decision to allow FDI in retail is suspended (mind you, not rolled back) till consensus evolves.  Immediate concern of course, is to get parliament to function which has been in a state of inaction for half the winter session.  Talk of Democracy!

It is claimed that FDI in retail will kill kiranas and farmers. Which of these opposing politicians (in bigger cities) have their kitchens run on groceries from kirana?  What has been done so far, to protect farmers who realize less than 1/3rd of what final consumers pay? What have we done about crores of post harvest losses? My street corner kirana shop owner has a son, who is in engineering school.  Do we really believe that the father is waiting for his son to inherit his 8 x 10, infested by roaches and rats? Emerging to emerged, evolution, modernization and better life - too much to ask?  Don't the opposing individuals (and their families) enjoy the luxury of foreign cars - why didn't we fight endlessly to protect Ambassadors? 

Granted that the effort to protect the interests of kiranas is genuine.  What about consumers?  Aren't we the foundation of economy?  As tax payers, we deserve to be taken notice of! How irresponsible it is to encourage a nationwide bundh of traders?  What a colossal loss of productivity?  What happened to the perishable produce and the interest of kirana, while protesters were busy trying to prove a point? Did your neighborhood kirana actually want to keep his shop and business shut?  Can the health of the ( local and global) economy afford this at the current juncture?

Advantages of multi brand retail stores are several.  Employment opportunities to tens of thousands of young and educated Indians (farmers' kids included), infrastructure development, better, equal and transparent prices / terms to farmers, investment in technology, growth in tax revenue and better consumer experience are only few of them. It is disheartening that political parties twist every national issue to improve its electoral prospects? Isn't there a mid path?  China introduced FDI in a phased manner to select states.  Can't we take a cue from there? Refusing to discuss (read work) an issue such as this and disrupting functioning of parliament - God, we need some serious help!

Apologies for my innumerable questions and out-of-ordinary choice of subject for "market talk". Louder our voices get, sooner will be some action - I hope.

Currencies are likely to be muted as markets count down to EU summit.  

Euro – will be or won’t be?

Whole world is pondering (and not for the first time) after almost 14 years of its coming into being. Euro came into existence in Jan of 1998 and took physical form in Jan of 2002.  To jog down the memory lane,  four monetary and budgetary convergence criteria for the member countries are (a) price stability (inflation criteria),  (b) stable exchange rate (with other member countries), (c) Government finance (threshold on gross debt and budget deficit as a % of GDP) and (d) interest rate (treasury rate as an indicator).

The sovereign debt crisis that is gripping GIIPS (Greece, Italy, Ireland, Portugal and Spain) is nothing but budget deficits created by excessive spending or insufficient tax revenue or both. France and Germany have had several budget deficit (as a % of GDP) breaches and got their violations waived; but Greece is a big one and financial markets are living with this nightmare!  This has put Euro’s debt crisis in bold on the dashboard of all and sundry and the world can’t take its eyes off the action (or lack of it)!

The union by all means encouraged free flow of capital to surging economies and it was meant to be.  However this caused imbalances in spending and fiscal deficits.  If only the peripheral economies had managed to get their act together and pushed up exports or attracted more capital inflows, the intensity of pain today would be far less.  Who wants to bet on dwindling economies with ballooning deficit and very low or no growth?  It’s a vicious circle!

The biggest challenge is lack of takers for sovereign bonds of some of its member countries. There are stories (hopes. Speculation and denials) floating around everyday dragging asset markets up and down (more down than up).  Can EFSF (European Financial Stability Facility) do the trick?

EFSF is a special purpose vehicle financed by member countries to help the countries facing debt crisis and to preserve financial stability in Europe.   EFSF promises substantial resources and is pushing IMF to play a significant role is fighting the situation. There is still no one number for the total firepower of the fund.  Hope it doesn’t turn out to be too little too late.

So will the union survive?  German and French officials are firefighting to calm the markets. But the pictures remains gloomy - growth, debt and unemployment and it is contagious.  It is a tall order to get the economies of Euro Zone integrated considering their very different internal dynamics.  Are we close to the end of another era?  Or could we expect a pleasant Christmas gift from European Summit scheduled for Dec 9?

What happens to Euro? The recent independent analysis by OECD, it stated the obvious and dismissed Euro’s chance of ever rivaling Dollar as a reserve currency (as once claimed by its founders).  Strange are the ways of the world.

While Euro’s existence is being questioned yet again, it still doesn’t seem to reflect the real state of the economy.  I am tempted to short the Euros some more! 

Slip and slide away...

There is a lot that’s going on in global financial market and even more at home.  Inflation woes, rupee finding new nadir every passing day (as we speak, there is a mighty hand at play helping our own battered currency), eroding investor sentiment and value (not necessarily in that order), ballooning current account deficit and the list could go on.  Currently though, the rate of depreciation of rupee seem to eclipse all other factors.

Indian currency has been Asia’s worst performer this year depreciating by a whooping 18% since August.  While the run on the rupee is triggered by Euro debt crisis, the stampede was more due to internal factor; lopsided positions with most imports and other dollar liabilities having been kept open when the markets were in a steady state and volatility abysmal. 

There is a variety of suggestion to control rupee’s slide.  Talk is cheap, right? One that particularly amuses me is to open a special window for importers. RBI seems to be telling the market ‘you made your own bed and now I’ll let you lie on it’.  They are doing a bit of damage control, but I don’t anticipate a great deal (and rightly so).  RBI may be micromanaging some areas to ensure overall health and compliance, but I believe market dynamics is merely it and should be left alone.

On the other hand, rupee seems to be achieving its equilibrium from a REER (real effective exchange rate) perspective.  Going by published statistics as of end October, rupee was overvalued by a little over 6.5%; it has depreciated close to 7.5% since.  Also NRIs are happily wiring $s back home to cash in on weaker rupee.  The trend would extend itself (I hope) for larger capital movements into the country.  These are some positives, though in long term.

Not for a minute it is being implied that the current level (or for that matter, any level) of rupee is the right level.  Panic and negative bias seem to be two strong elements of market force, at present.  Rupee seems to be slipping and sliding away feeling light as a helium balloon (but in  opposite direction).

So what to do we do?  We have a bunch of exposure unhedged / hedged and have no clue where the market is going! Good news is, you are not alone.  Better news is, it forces you to rethink your risk management strategy.  Market is ever changing (and challenging) and it’s important to consider insulating business from bizarre event/s such as this.

Time to go back to your drawing board!?

Structured approach to risk management

Globalization, tighter regulatory requirements and increasing shareholder involvement have re-defined the nature of risks faced by organizations.  As business environment is becoming more and more competitive and complex, boardroom discussions increasingly dwell upon internal control and risk management as effective tools to survive and excel. 

Market risk management is an important aspect of business and appropriate attention to this ensures that volatile financial markets don’t result in volatility in financial performance of an organization.  It is imperative to understand how market changes (changes in currency, commodity and interest rates) affect businesses, in order to plan and react quickly to events. It needs no further emphasis that market risk management is pivotal to running a business efficiently.  Let’s take a quick look at important ingredients of sound risk management:

Firstly define Objective. Sounds obvious, right?  In reality, it is often unclear whether an organization is looking to out do market or protect its budgeted rates or avoid accounting losses or run its treasury as a profit centre or a mix of some / all of the above.  Setting objective / benchmark to measure performance is first step to managing risk proactively.

Approach to managing risk should be arrived at, after careful consideration of various aspects viz (1) organization’s risk tolerance (2) how to gauge exposure and risk (3) historical simulations (4) stress / scenario testing (5) why should the exposure be hedged (6) when and what should be hedged (7) cost of hedging (8) internal resource availability (people, skill, systems& bank limits), (9) management commitment etc. 

Strategy: (a) management style (Is it going to be one of dynamic? all or none (100% or 0%) hedge? net or gross exposure management? based on cost of trade finance?) (b) define internal authority on hedge decisions (c) products (forwards, options, swaps) / tenor and approval matrix (d)  MIS and escalation process (e) front office / back office segregation (f) whether external expertise to be sought for day-to-day decision making? and so on.

Monitoring and Control: Monitoring indicates performance measurement. It helps identify gap in resources, training / system needs etc. More importantly, monitoring and control ensure compliance and enable periodical fine tuning of strategy and adapt to changing business environment.  Corporate risk management is a process, after all.

Risk Management Framework / Policy documents all of the above and disciplines risk management practice. A board approved policy is the best form of communication to all stakeholders on how risk is being approached and mitigated.  Increasingly regulators and financial institutions derive huge comfort from a corporate customer with a structured approach to risk management.

POIESIS risk solutions would partner with your organization to help you effectively manage market risk.  Our service is customized to suit your current preparedness, individual needs and would be tailored to tackle key risk management challenges.