JPMorgan Recommends Options as Indian Rupee May Slide

Economist kancha : Indian RS has fallen the most since 1991 ,I would like the readers to discuss the reason behind it . I was watching kadlow and company this evening ,Mr kadlow was taking about global economy slowing down ,which is one of the reason why oil closed at 102.61 .What is the re ason behind RS to fall ? WHat can be done? Monetary policy is already tight to curb inflation .WIll lowering the money supply help or something else needed to be done .. trade deficit is growing ,which means to strenghth the rs ,dollar can not be sold

By Anil Varma Sept. 9 (Bloomberg) -- Investors should use currencyoptions to guard against losses as India's rupee heads for thesteepest slide since 1991, when a balance of payments crisisforced the nation to pawn its gold, JPMorgan Chase & Co. said. Investors should buy rupee put options granting the rightto sell the currency against the dollar, said Vikas Agarwal, astrategist at the third-biggest U.S. bank. The rupee will fallto a two-year low by Dec. 31 as funds pull money out of emergingmarkets, he said. ``The odds of further rupee losses are more as fund flowsstay weak,'' Mumbai-based Agarwal said in an interview. ``Addedlosses will stoke expectations of prolonged rupee weakness, andthe ensuing adjustment in the currency would be swift, sharp andpotentially disruptive.'' JPMorgan recommends buying options as ``insurance'' againstsuch a slump, forecasting the Indian currency will drop to 45per dollar, its lowest since November 2006, by the end of thisyear. It closed at 44.825 against the dollar in Mumbai. Such a decline would take the year's loss to 12.4 percent, the most since 1991's 29.7 percent, according to data compiled byBloomberg. The rupee is the third-worst performer among the 10 most-active Asian currencies this year with a 12.1 percent loss. Thecurrency advanced 12.2 percent in 2007, the biggest gain sinceat least 1974. Investors should buy a rupee put and with a so-calledstrike price of 47, which is 3.8 percent higher than the rupee-dollar contract due by the end of December in the currencyforward market. Forwards are agreements to buy and sell assetsat current prices for delivery at a specified time and date.
`Rupee Volatility'
``Although this option isn't cheap anymore due to increasedrupee volatility, it still protects against outsized losses inthe currency,'' Agarwal said. Implied volatility on one-month dollar-rupee options roseto a one-year high of 11.8 percent today, Bloomberg data show.Traders quote implied volatility, a gauge of expected swings inexchange rates, as part of option prices. Options are derivative contracts that give the holder theright to buy or sell an asset without the obligation to do so. Astrike is the price an option holder may buy or sell a currency.Forward rates adjust for interest-rate differentials betweencurrencies. The rupee is headed for a third quarterly loss as overseasinvestors pulled out almost $7.5 billion from local equitiesthis year. India's benchmark share index has lost 27 percentthis year, following 2007's 47 percent advance. ``Capital inflows have slowed to a trickle and a sustainednear-term rebound looks unlikely owing to a still tentativeglobal backdrop for risk-taking,'' Agarwal said.
Current Account
The rupee will also weaken as the South Asian nation'scurrent-account deficit widens, he said. The deficit, a measureof trade and investment flows, increased to $17.4 billion in thefinancial year ended March 31 from $9.8 billion in the previousyear, central bank data show. India's central bank may ``check the possibility of runawayrupee weakness'' by intervening in the local currency market tosell dollars, Agarwal said. Dollar sales by the Reserve Bank of India in June exceededpurchases for the first time in 20 months, a central bank reportshowed last month. The monetary authority sold $7 billion duringthe month and bought $1.77 billion, taking net sales to $5.23billion. The Reserve Bank's foreign-exchange reserves havedeclined by almost $21 billion from a record high of $316.2billion reached in May, indicating it sold dollars.
1991 Crisis
India faced a balance of payments crisis in 1991 when theIraq war sent oil prices higher, inflating the South Asiannation's import bill and depleting its reserves. That forced thecountry to pledge its gold reserves with the InternationalMonetary Fund to borrow foreign exchange to pay for imports. A falling rupee will stoke demand for options designed toprotect against currency losses, boosting the value of suchcontracts, Agarwal said. ``That would give an opportunity to unwind the option witha profit before it expires, by selling a similar contract at ahigher price,'' he said.
--Editors: Chris Young, Sandy Hendry