How to play a short, sharp rise in the Indian rupee

India's rupee is down 18% against the US dollar since March. But smart spread betters might want to position themselves for a short-term bounce, says Tim Bennett. Here’s how.

It's been a dire few days for the Indian economy. Domestic factory output has contracted for the first time in more than two years it fell by 5.1% from a year earlier in October. There is also widespread concern about the Indian government's ability to implement economic reform to attract more foreign capital.

And investors have plenty of other reasons to be nervous about India domestic inflation is still barely under control, growth is slowing and the continent is exposed to the unfolding euro crisis. No wonder the rupee is down 18% against the US dollar since March.

However, in the short term, smart spread betters might want to position themselves for a bounce.

That's for one main reason the authorities are likely to act. And act soon. The rupee is Asia's worst-performing currency and sank to a new low against the US dollar this morning. Meanwhile last month's slump in India's foreign exchange reserves was the most seen since the $39bn drop that followed the collapse of Lehman Brothers.

So, many analysts expect tough measures to stop the rot. These are very unlikely to include further rate rises most analysts expect them to stay on hold as inflation is showing signs of levelling off.

However, "we could see measures like allowing oil importers to buy dollars directly from the RBI [India's central bank]" (that should ease dollar liquidity necessary when one-sided demand for dollars from importers isn't matched by dollar selling by exporters) says Anindya Das Gupta, managing director at Barclays Capital in the Wall Street Journal. The RBI has ruled nothing out so far and a "definitive statement" is expected at the next rate-setting meeting on Friday.

Next, and a key reason for an intervention, is that the sell off has been overdone, says Sajjid Chinoy, India Economist at JP Morgan. "India's balance of payments fundamentals did not worsen so materially so as to justify another seven per cent depreciation in November". He expects the RBI to act to "break... the cycle" to moderate speculative selling of the rupee.

These would both be valid reasons to be short the US dollar against the Indian rupee in the short term. However, with the US dollar strengthening, in the face of the ongoing euro-crisis, a better bet is short euro/Indian rupee.

As ever with spread bets, set a stop loss to limit the damage should the authorities decide against further action as that decision could send the rupee into yet another nosedive.

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