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October 10, 1997


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Business Commentary/Harshad Mehta

India can gain from South East Asian currency crisis

The last couple of months have seen one of the biggest upheavals in the financial and equity markets of South East Asia. This is an interesting phenomenon considering that this region is expected to provide much of the future growth of this planet. An interruption at this stage has suddenly raised the question of whether the South East Asian miracle was over-hyped, and if so, whether India will also be systematically downgraded over the coming months.

The Indian question is particularly relevant for all of us on the stock market. It was only in August when we foresaw the foundation of a major boom on the stock market. Suddenly, a wave of international selling hit the Asian stock markets, India included. To add to our worries, the prime minister made a reference to the fact that the rupee would be allowed to float within a certain band. This was interpreted as a signal that the rupee would be allowed to weaken to enable Indian exporters to earn more. And sure enough, the rupee lost strength against the dollar for the next few weeks.

In one of my earlier columns, I highlighted the grave dangers of a falling rupee. Gone are the days when a weak currency would be welcomed by the stock market as increasing our competitiveness in the global markets. In today's times, the first sign of weakness in the currency causes panic among one of the biggest emerging stockholding entity -- foreign institutional investors. To encapsulate the argument, the FIIs hope to make money two ways: by an appreciation in the value of their stock, and through an appreciation in the strength of the currency they hold the shares in. If the currency weakens even as the shares gain, the FIIs may not take home much, and in some instances might even lose money. Besides, a weak currency causes an exit of funds and particularly when the volume of flight is heavy, the currency loses further ground.

There could perhaps be no better example of what international currency trading and perceptions can do than the Malaysian currency. The currency has lost strength over the last few months with traders selling aggressively. Worried that this would slow in flow of fresh funds into his country, Malaysian PM Mahathir Mohammed accused George Soros of having perpetrated the crisis. I watched the speeches made in Hong Kong wherein the Malaysian PM accused Soros of having indulged in something immoral and Soros retaliated by saying that the PM was only trying to cover his inefficiency.

It is an interesting commentary on the world that we live in that a problem in some of the South East Asian countries has actually had a fallout on India in the form the decline in the rupee's strength. This is what the borderless world is all about. In the future we shall see increasing instances of something going wrong in some country that actually takes the bottom out of Indian equities.

The recent decline in the rupee's strength among other reasons can also be attributed to the following factors:
* Our markets are heavily exposed to FIIs who structure their portfolios as per geographical allocations. The perception that there would be a huge redemption facing some of these funds following the rupee's weakness prompted a drop in Indian equities.
* The perception of the redemption itself was larger than the actual redemption. The result was that buying enquiries evaporated and various hedge funds operating on the short-term trend started selling. This frightened the investors away.
* Various FIIs offer an Indian index option to their investors abroad. A hedge is created against this position by buying into Indian index stocks. Once uncertainties emerge, the international investors start offloading their investments made in the index options. This creates a downward pressure on equities.
* On a number of occasions, the brokers and speculators build positions on the advance information of some large funds investing or disinvesting in particular stocks. In the recent past, this segment caused prices to drop even before the FIIs could liquidate their positions.

In the light of this, what has transpired over the last few weeks in India has been absolutely amazing. Even as some of the Asian Tigers have lost ground -- the Thai baht used to be 30 per cent stronger than the Indian currency against the dollar, today it is 10 per cent weaker -- the rupee has done relatively well. It lost ground in the aftermath of the PM's statement, but slowly and surely the currency has waged an absolutely incredible rebound. As an Indian, I am awed.

More importantly, the official agencies have begun talking the right language. The Reserve Bank of India governor clearly said that he expected to rupee to stabilise around Rs 36.20. The finance minister hinted that forex inflow interests would be taken into account in connection with the strength of the rupee. No more market friendly statement has been made in recent times: this clearly implies that the government would not be in favour of a weak currency because this could have an adverse impact on the inflow of capital into the country.

And more recently, Merril Lynch in its report assessed Indian stocks as a stable opportunity. In my opinion, this is an opportunity that we must capitalise on by getting our homework very clear on the following points:
Position India as a financial centre by enforcing depositories with more corporates, making the buyback of equity legal, and making options and futures a reality.
Permit more Indian companies to list their shares abroad.
Permit domestic investors to raise resources against the value of their holdings within the country and outside India.

Over the next few weeks, if the government can make the right noises and talk up the rupee, it will be a remarkable emerging opportunity in South and South East Asia -- at a time when the other currencies are weakening, India will have staged a surprise of sorts.

And if this financial inflow comes into the stock market -- as it must -- our equities will stage a rebound. If you are worried that this may hamper exports, remember that a strong currency enables corporates to restructure their debt and become more competitive in the medium-term. Win-win!

In mid-August, when the Indian currency began weakening, I became bearish on the stock markets. With the rupee having rebounded, I am confident that the stock markets will follow suit.

Harshad Mehta

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