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Economy Feb 7, 2012

Asia’s superhero: The zero-to-hero story of rupee

By Firstbiz Editors

ACT I:
Once upon a time, there was a currency called the rupee. Like most currencies, it spent most of its days travelling quietly through Forex Street, minding its own business.

Then one day in August 2011, a gang of foreign currencies, led by the US dollar, ambushed the rupee and started pounding it viciously. They did this day after day, and the skinny rupee had no defence. It started to drop its value rapidly, so much so that by 15 December, 2011, the rupee slipped into a coma as it dived to an all-time low of 54.30 against the dollar.

It became the worst-performing currency across Asia in 2011.

The people who knew the rupee - analysts, bankers, traders and investors - were shocked at what had become of the partially convertible rupee. Several of them gathered on Forex Street to conduct a mass prayer ceremony for the health of the floundering rupee.

In the back of their minds, however, they were preparing for the funeral march of the rupee as bets increased that the local currency could slip even further against the dollar.

Nothing, it seemed, could rescue the rupee...

ACT II:
Meanwhile, divine forces were at work in other parts of the world. Two saviours appeared out of nowhere, heeding the fervent prayers of Indian rupee devotees on Forex Street.

The first one emerged in Europe in the form of the European Central Bank. Around the same time as the rupee swooned, the central bank of the 17-nation eurozone sent a massive hail of liquidity into the world as it pledged to provide unlimited cheap money to the region's beleaguered banks.

Without liquidity, the rupee could easily shrivel again.Photo: Nicocrisafulli/Flickr

An anticipated interest rate cut some time in the first half of 2012 built expectations of another flood of liquidity as well.

The second saviour came in the form of the US Federal Reserve, which promised to keep interest rates at a historic low until late 2014. Investors around the world took that as a godsend to go out and borrow cheap and invest in relatively riskier (and high-yielding) assets around the world without fear of any hikes in interest rates for a few more years.

Expectations also grew of an encore of Operation Twist (introduced by the Fed in September 2011) to further boost the availability of cheap money.

The downpour of liquidity (and the promise of more to come) from the ECB and US Federal Reserve had one extremely potent quality: any object exposed to sufficient quantities of it became highly desirable and, thereby, powerful.

ACT III:
That liquidity soon started being showered around by global investors. The result: several currencies across the world from the Mexican peso and Brazilian real to the South African rand emerged stronger in the New Year.

Some of that liquidity also made its way to Indian shores. The effect on the rupee was electrifying. Almost instantaneously, the local currency started getting stronger. In a few weeks, it was off intensive care and on to stamina training. (Of course, some credit must also be given to the care of well-wishers like non-resident Indians, who bid up the value of the rupee by increasing their deposits in India, and the Reserve Bank of India, which tried to beat down the value of the dollar with a host of measures to prevent the greenback from getting too aggressive again.)

Soon, the newly muscle-bound rupee became strong enough to batter its previous tormentors (the dollar mainly). By early February 2012, barely-six-and-a-half weeks after it fell into a coma, the rupee rose to 48.60 against the dollar, putting on a hefty 8 percent.

Indeed, from the region's worst-performing currency, the rupee became Asia's best-performing currency. Like that comic book hero, Superman, the once skinny weakling had turned invincible, pumped up by huge doses of liquidity.

Bankers, analysts and investors were shocked again -- this time at the currency's rapid recovery. Funeral song sheets were hurriedly ripped apart and replaced by a peppy dance number celebrating the amazing return of the rupee.

Of course, we all know that every superhero, no matter how powerful, always has one fatal flaw...

ACT IV:

Superman's biggest weakness, for instance, was green kryptonite. The rupee has its kryptonite too: the Indian economy, whose bad performance on the trade front (a current account deficit of more than 3 percent) and local front (high inflation and slowing growth), has the power to weaken the currency and reverse the rejuvenating effect of liquidity.

If the rupee's arch-rivals, the dollar and euro, succeed in bringing the economy's weak performance centrestage, investors could decide to pull the plug on liquidity. Without liquidity, the rupee could easily shrivel again.

For now, however, a battered dollar and euro have been unable to come up with a game plan to bring down the rupee.

So will the rupee reign supreme? Hardly. Every good comic book story has its share of unanticipated twists and turns.

Asia's currency superhero will be no exception.

by Firstbiz Editors

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