Rajan Roulette Warning Ignored as Rupee Volatility at 2008 Low

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The lowest volatility in India’s rupee since 2008 is breeding complacency among borrowers and investors, raising the risk they will ignore central bank advice to hedge.

Measures of expected swings for the rupee dropped the most in Asia as Reserve Bank of India Governor Raghuram Rajan builds a war chest of foreign-exchange reserves to shield the currency. Scotiabank, the second-best rupee forecaster in Bloomberg’s quarterly rankings, says while the central bank’s intervention has made currency moves more predictable, it also provides companies a disincentive to protect against losses.

“It may be harmful as market participants may take it for granted that the RBI will always ‘be there’,” said Sacha Tihanyi, a senior currency strategist at Scotiabank in Hong Kong. “When volatility kicks off, like in 2013, a lot of participants may face losses on unhedged positions or foreign-currency borrowings.”

While easing tensions in Greece and the slide in oil are boosting investor confidence, the Federal Reserve looks set to raise interest rates this year in a move that could see global funds pulling money out of emerging markets. Rajan in February likened borrowing in dollars to playing Russian roulette and urged firms to hedge more as risks around the world rise.

The rupee sank to an unprecedented low in 2013 after the Fed’s signal to end bond purchases triggered an exodus of funds from developing-nation assets.

‘Minsky Hypothesis’

The rupee’s one-month implied volatility, a measure of expected moves in the exchange rate used to price options, slid to 4.77 percent on Tuesday, the lowest since February 2008, data compiled by Bloomberg show. That compares with this year’s high of 8.79 percent reached in May. It was 5 percent Wednesday.

Indian companies have raised about $13 billion from global bond issues so far in 2015, with $12.7 billion of that in dollar debt, data compiled by Bloomberg show. Foreign-currency issuance was a record $22.05 billion last year.

“There’s surely some complacency among market participants,” said Divya Devesh, Standard Chartered Plc’s Asia foreign-exchange strategist in Singapore. In this scenario “Hyman Minsky’s hypothesis comes to mind - stability leads to instability,” he said.

Hyman Minsky, who died in 1996, was an American economist who argued that long periods of stability can reach tipping points and rapidly degenerate into chaos.

‘Massive Implications’

The rupee’s three-month implied volatility dropped 12.3 percent in the month through Monday, the biggest decline in Asia, data compiled by Bloomberg show.

“Given what is on the horizon for the rest of the year, especially the Fed rate hike, which has massive implications for emerging-market currencies, I think we might not get a sustained period of range-bound trading in dollar-rupee,” said Viraj Patel, a currency strategist at ING Groep NV in London.

The rupee sank to a record 68.845 a dollar in August 2013 and one-month swings widened to as much as 22.8 percent as overseas investors sold about $9 billion of local corporate and sovereign debt in the June to August period that year.

The currency has since risen about 8 percent to 63.5175 a dollar Wednesday, Asia’s best performance in the period, as Rajan, who took charge at the central bank in September 2013, initiated measures to boost the supply of dollars, including a concessional currency-swap facility for banks.

‘Slumber Mode’

Top forecasters see the rupee falling toward a two-year low as policymakers look to arrest a slowdown in exports, which slid for a seventh month in June in the longest stretch of declines since 2009. ING, which had the most accurate estimates in Bloomberg’s quarterly rankings, predicts the currency will depreciate to as low as 66 a dollar by year-end.

The RBI bought $35.7 billion from the spot market alone in the five months to May, official data show, helping propel foreign-exchange reserves to a record $355 billion last month. That’s spurred speculation the central bank will step in to shield the currency if needed.

The rupee has weakened 0.8 percent so far in 2015. The RBI’s intervention is only to mitigate volatility, Deputy Governor Urjit Patel said in an interview with a local television channel this month.

“Trading has gone into a slumber mode and the next trigger could come in the form of a Fed rate increase,” said Rohan Lasrado, the Mumbai-based head of foreign-exchange trading at RBL Bank Ltd. “Everybody is so complacent now that they feel we’re ready for the Fed. They could be in for a surprise.”

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