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On a year-end television programme, the anchor asked me (who was, as usual, bullish about India) and my co-panelist (who was, as usual, bearish about India) what would be our investment currency of choice for 2012. Well, we both agreed on the rupee being the best bet.

My co-panelist felt that with a 3-5 year horizon, the rupee could earn 9 per cent relatively risk-free and would outperform most other currencies; even if it did not strengthen. My view is more aggressive: in addition to the interest gain; I expect a currency appreciation of at least 5-6 per cent over the next two years. But the rupee could certainly weaken from the current 52-53 level if the dollar continues to strengthen overseas, which has a high probability. The dollar has been weak for a long time — the dollar index or DXY fell from 120 in 2002 to 70 right before the mortgage crisis erupted in 2008 — which increases the probability of a turnaround. It has already recovered some ground (at around 80) confirming that in a crisis, the dollar is still the currency of choice. The market has been driven between what is called "risk off" — when investors feel uncertain — and "risk on"; and the dollar has been responding in kind: rising when risk aversion is high (risk off) and falling when investors feel a bit more aggressive.

However, since October-end, the music seems to have changed. The dollar has risen from about 75 to 80 despite the fall in risk aversion — as measured by the volatility index, VIX. The VIX is now at a level that has historically signaled an increase in global risk appetite and inflows into emerging markets. Of course, with the year-end, markets are thin, and it is generally not a good idea to come to definitive conclusions. Nevertheless, my optimistic heart cannot help but notice these elements, which, if they persist into the New Year, could signal, a continued resurgence in the dollar and a renewed interest in risk assets — notably emerging market equities and currencies.

For the rupee, there are conflicting signals. A strong dollar would generally translate into a weak rupee, particularly, given the still heavily short dollar positioning of the domestic forex market. On the other hand, if dollar strength is driven by a sense that the global economy — and the US, in particular — is not as bad as people had believed — certainly my view — it would also portend a renewed flow of investment into India.






As we all know, most investors have been sitting on a lot of cash for some time now. And, again, despite the so called "policy paralysis" and the rona dhona of many of our captains of business and industry, the India investment story is very much alive; it is quite well and  actually kicking — during April-October 2011, foreign direct investment was up 50 per cent relative to the previous year.

I see continued volatility in the rupee, certainly in the early part of next year, which is not a bad thing, always. Perhaps, the main reason we have got into this near-crisis situation is because rupee volatility was much too low for most of 2011. With the rupee steady around 45 from the start of the year till about August, forward premia as high as 6 per cent, and, it must be said the inertia-fed view that the rupee can only strengthen, few people with short dollar positions (importers and companies with ECB's) could be convinced to buy dollars. I know. I tried.

And, of course, when the wheel turned, with the dollar shooting up in September, there was plenty of blood on the streets and balance sheets. If rupee volatility had been higher, it is likely that more companies would have hedged themselves, at least, partially.

Coming back to the market, another twist in the tale is, of course, the Euro. Will it or won't it   hold together? To my mind, it will. There is too much invested in its sustenance and the cost and process of unwinding will, perhaps, be too much for the European economy to take. The side effect of keeping it together will, bring a dramatic change in European governance, with profligate democracy giving way to a more Germanic control. Indeed, it is ironic that as West Asia is discovering and demanding more self-determination, countries that have been democratic for decades, including India and the US, are finding themselves pushed against the limits of democracy.

When the market fully accepts that the Euro will hang together, despite the ongoing wobbles in the sovereign debt market, it could trigger a relief rally, further adding to global volatility. But once the realisation becomes widespread, it should give way to the underlying dollar strength since the only way that Greece and other weak European economies can survive is if the currency remains much weaker.

Thus, look for more wildness in 2012: a rupee ranging between 47 and 57, with an average somewhat stronger than 52.50; the Euro could dance between 1.20 and 1.35.

(This story was published in Businessworld Issue Dated 09-01-2012)