Re to be affected by $ moves than FII inflows : Economic Times 2nd June 2010

Madan Sabnavis

THE yo-yo movements in the rupee are significant today.Conventional wisdom says that the day-to-day fluctuations in the rupee would be driven more by the capital inflows i.e.FII funds,under ceteris paribus conditions.However,things have been quite different this time round with the rupee being driven more by an extraneous force,which is contrary to the impressionistic view that we would have about the role of FIIs.
The main factor driving the exchange rate has been the strength of the dollar.The dollar has depreciated against the euro for some time on account of the high deficit on both the current account and fiscal fronts,which combined is 14.3% of GDP.However,ever since the euro crisis deepened,the dollar has appreciated vis--vis the euro,with talks of parity now being a possibility with the rate coming down to 1.20.Even though the bailout package for Greece is on,there are doubts over Greece adhering to its part of the agreement i.e.fiscal stringency and the sustainability of the euro nations union and the concept of the euro with several shadows being cast on member nations.
In this scenario,currencies have turned volatile with wild fluctuations being witnessed on a daily basis based on what the market perceives of the Euro currency economy.Fund movements have been quite idiosyncratic swinging between stocks,commodities and bonds across markets looking for better returns.
The table below gives the annualised daily volatility for the dollar relative to the euro and rupee relative to the dollar since January.
The dollar-euro relationship has been volatile all through and reached its peak in May at 13.3% when the rupee started depreciating.In fact,the rupee has become progressively more volatile in the past 2 months and comparable with that in the NIFTY with the ratio of forex volatility to stock market volatility moving up from 40% between January and March to 52% in April-May.
In this context,it is interesting to see as to what has driven the rupee: the exogenous euro-dollar relation or the endogenous factor of FII inflows.While one would have thought that the swings in the rupee rate was due to the FII flows which turned erratic,surprisingly,the coefficient of correlation between changes in the rupee-dollar rate and FII inflows was insignificant at -0.02 while that with the euro-dollar rate was better at (-)0.33.(Negative sign means that as the dollar strengthens,the rupee weakens).
Curiously even in the month of May,when the rates were most volatile,the coefficient of correlation was -0.38 with the euro-dollar and +0.21 for the FII/rupee-dollar relation.In fact,the latter shows that when there are more FII flows,the rupee depreciates i.e.has a higher value.Evidently the exogenous global conditions have a greater bearing on the rupee-dollar rates.
Also a regression analysis for changes in exchange rate on FII levels and dollar-euro rate shows that the former is not significant,meaning thereby that the rupee-dollar rate was not really affected by the FII levels.Global conditions have definitely been more critical here.
This means that in the medium term,defined as long as there is apprehension about the state of the euro,the rupee will be guided more by what happens externally to the dollar,which in turn is drawing some benefits from the euro weakening rather than the dollar strengthening.Typically exporters/importers should monitor these numbers closely.