Credit Suisse sticks its neck out: Says FX trading on Indian Rupee is fine despite mess caused by cash ban

Go long on the Indian rupee and ignore Indian Prime Minister Narendra Modi’s surprise ban on cash.

That’s the somewhat surprising advice from Credit Suisse, the world’s 14th largest FX dealer by market share, to emerging-markets investors looking for bets to counter a strong dollar.

In November last year, Financefeeds reported that India’s government had banned 500 and 1000 INR notes, especially pointing out that there are giant reserves in the hands of citizens of Nepal who could sell them on to ease transfers.

At that time, the value of the rupee reached extremely low levels, however FinanceFeeds opinion at the time was that exchange traded Indian rupee contracts which are dominant at emerging venues such as at the DGCX – home to 31% of all rupee trading – could present a massive opportunity as a result of this.

Credit Suisse’s comments today prove our analysis to be correct, however it would take a trader with nerves of steel to actually go down this route.

“We like the rupee as India has a very strong basic balance surplus, which affords a shield against the rising US dollar and interest rates,’’ Koon How Heng, senior FX investment strategist at Credit Suisse has stated publicly this week. “A lot of people don’t realize this because the attention is on demonetization” he said.

“Emerging market countries with strong basic surpluses are better poised to withstand risks of capital outflows,” he said, contrasting India’s outlook with Indonesia, which has been running fiscal and large current-account deficits. “This year will be a year of dollar dominance.”

Indeed it may be another year of the dollar’s prized position as the currency by which to benchmark everything else, however the Indian rupee, despite its massive circulation as the national currency of a country with over 1.3 billion people and a huge industrial base that varies from agriculture to management consultancy to computer science, will never cut it as a desirable unit by which to trade the electronic financial markets.

India, whilst its total GDP is the third in the entire world at $8.72 trillion, is an unstable mess as far as economic policy is concerned.

Just one month before the banning of 500 and 1000 INR notes, a $10 billion position was left unhedged within the FX deposit redemptions section of India’s banking system which analysts at the time considered to be the potential cause of a possible depreciation in value of the country’s sovereign currency during the ensuing months. Negligence such as this at central bank level are not something that mainstream traders can put their faith in.

The question is, would now be a good time to trade the Indian rupee?

On November 8 this year, the Indian government suddenly canceled its two largest rupee notes, the 500 rupee and 1000 rupee notes, in what it described as an anti-corruption measure, announced on national television by Prime Minister Narendra Modi.

Whilst the decision, which was unexpected by the population, was aimed at fighting corruption and money laundering – both absolutely rife in India – this created absolute havoc and rendered large quantities of currency completely worthnless overnight.

The Reserve Bank of India (RBI) estimated in November that there were 16.5 billion 500 rupee notes and 6.7 billion 1000 rupee notes currently in circulation. ATMs were shut on November 9 and 10 to help implement the change, however vast lines of people amassed in many areas outside ATMs, and physical fights broke out between people scrambling to extract money from ATMs whilst battling massive crowds.

What a mess.

Further problems ensued because more than half of India’s 200,000 ATMs had not been reconfigured to dispense the new 2,000-rupee ($40) notes introduced by the government, according to Finance Minister Arun Jaitely. He said it would take two to three weeks for all the ATMs in the country to be recalibrated to handle the new notes.

The value of the rupee absolutely collapsed immediately after the government canceled the 500 and 1000 rupee notes. When comparing it to the very stable US dollar, it was clear at the time that confidence is not the only problem, as shortages of currency, suddenly worthless centrally issued bank notes and a devaluing of the entire economy had decimated the value of the rupee.

Another example of extreme instability and bungling which leads to absolute mistrust and lack of faith came just two weeks before the government canceled the two denominations.

In mid-October, a $10 billion position was left unhedged within the FX deposit redemptions section of India’s banking system which analysts considered to be the potential cause of a possible depreciation in value of the rupee over the next few months.

Whilst some analysts were bearish, some actually did consider this to be a potential liability, as such a drop would act as a booster for exports and possibly narrow the trade deficit although imports of oil and other commodities would become costlier, said experts, some of whom suggested the gap may have deliberately been left uncovered. Not anymore it won’t!

Three years after the Reserve Bank of India sought to shore up the rupee through foreign currency non resident-bank (FCNR-B) deposits, the country is bracing for an outflow as these are redeemed.

Whilst all of this unfolded, there are nations around India’s periphery which have open borders with India, and whose populations are flush with 1000 and 500 rupee notes.

On November 22 last year, private sector firms in Nepal began lobbying the Nepal Rastra Bank to initiate FX intervention to bring 500 and 1000 rupee notes which are in the possession of the Nepalese public and traders near the border within the banking channel to provide an effective exchange facility.

This created an unofficial street value of higher than the nominal value of what are now illegal tender. Beyond comprehension!

Due to Nepal’s open border with India and regular flow of people to and from the southern neighbour, many Nepalese people have some stock of INR 500 and INR 1,000 notes for daily transactions, which could amount to billions.

This volatility was caused by extremely alarming circumstances that would never take place in an organized economy – India has, despite its vast industrial base and blue-chip commercial interaction with Western telecoms, technology and consultancy firms, a completely disorganized economy.

Only 2% of India’s population pay tax, owing to the enormous unofficial economy that operates with every small business from taxi drivers to shop owners transacting everything in cash and never reporting it, hence the government’s draconian crackdown.

What if FX traders could turn this to their favor?

Take a country with the third largest GDP in the world, and a volatile currency. Clearly the country’s productivity is very high and the need for global businesses to transact from USD to INR is huge in order to sustain this.

The low value of the rupee may only be temporary, however anyone wishing to make spot FX transactions would have to have nerves of steel.

Bearing all of this in mind, the Dubai Gold and Commodities Exchange (DGCX) has emerged as a prominent new exchange over the last five years, largely due to its Indian rupee futures contract.

Indeed, the Indian rupee futures contract traded on DGCX accounts for over 31% of all global exchange traded Indian Rupee market share.

In other regions of the world, the discussions relating to potential moves onto exchanges by FX firms has largely died out, even in North America, which leads the world in exchange-traded products from the derivatives and exchange technology powerhouses of Chicago.

It is easy to see why. In Chicago, clearing and membership fees of a vast, long established electronic derivatives marketplace would be prohibitive, and the OTC market is buoyant and stable. In India and certain parts of the Arabian peninsula, however, things are very different indeed.

DGCX membership and clearing fees are a fraction of those of the giants of the MidWest, and the Indian rupee futures contract is a roaring success as a futures contract.

Now, with low rupee values and a very uncertain fiscal policy in a disorganized country which has a massively productive economic structure, this could be the actual dawn of the Indian rupee’s rush to popularity as an exchange traded asset.

Placing a futures bid on a currency such as the rupee on a long position, whilst it is in disarray, on a venue which is highly energized in rupee trading, based in an economically (by Middle East standards!) stable location could appear to be quite interesting, especially when taking the instantaneous nature away from the transaction, and matching it against indices and commodities.