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Solutions to curb market volatility and support the falling currency

Guest post by
Surabhi Shah, Consultant, Infosys


With the fluctuating market trends and growing need for more foreign borrowings has changed the face of Indian economy significantly. Tracing the genesis back of the rupee-dollar relationship, rupee's journey has taken several folds since 2012.  The year 2012-13 has been a roller-coaster ride for Indian Rupee with rupee depreciating all time low to 68.80. As a stepping stone, RBI came up with continuous measures to tighten the liquidity in the economy and to support the depreciating currency. With India being a developing economy and sky touching inflation, the depreciation of currency was quite evident. However, to curb the scenario, improvement in local macro economic factors is the most fundamental variable to sustain appreciation of Indian currency and economy growth in medium term.

If we go deeper down, the tumbling rupee, mounting Capital account deficit & shaking economy are just symptoms to the illness. RBI announced a series of measures to provide a backbone to the falling scenario of Indian currency. The reaction to the RBI's current measures was immediate in the banking and capital markets. Banks derive revenues mainly from three streams - treasury, credit and fee-based activities. The effect of the RBI measures was more on the first two impacting banks heavily. Banks got hit on treasury books due to rise in yields which caused a temporary pause on cheap availability of funds. On credit front, banks can channelize their excess Statutory Liquidity Reserves into lending. Also, in due course, some banks may raise short-term deposit rates to get bulk deposits which will lead to rise of credit costs.

Trading sentiment, mainly in financial and banking sector, is stifled after RBI measures to curb rupee volatility. From bank's perspective, the nature of the RBI's measures are temporary and are precisely directed at regulating the irrational volatility in the foreign exchange market and hold no other significance. Liquidity tightening measures by the RBI helped little to stabilize the rupee, in contrary increased volatility in the bond markets by triggering yields to rise across the curve and have put India's economic growth in jeopardy. Stock markets reacted negatively to the RBI's stance and concerns over growth and inflation outlook. As a corrective measure, banks reduced mark-to-market losses on bond portfolio with the expectation that bank stock prices would move up and that tide would lift the markets up.

The fluctuation in key market variables is playing major role in making the situation more unpredictable. Current IT companies offer multiple risk management solutions to capture the market fluctuations and to estimate the losses arising due to the risk factor movements. One such functionality is available in Oracle Financial Services Analytical Applications (OFSAA) market risk solution; it provides the provision to configure present currency depreciation as one of the stress test scenario and perform analysis around it. Different stress test scenario can be derived where all market variables interest rates, exchange rate, equity/ index prices can be shocked to determine change in the market value. Using stress testing framework user can define variables (% changes in risk factors) and combine them into stress scenarios. These tools driven by top notch companies are useful to identify and encapsulate market movements. As an add-on feature OFSAA provides back testing capability across multiple portfolios to guarantee the profitability and devise strategic measures. In current market scenario, performing backtesting measures based on a user defined look back period can lead to a successful strategy.


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