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How the sharp move in the INR has affected Futures markets

Over the last month, traders of commodities futures in India have been facing a market, which has been

broadly disconnected from the movements in overseas markets.

Whats driving the INR

Over the last two months, the Indian Rupee has shown one of its sharpest waves ofappreciation in history. The move has been literally a linear one with a surprising absence of central

bank intervention. This never-before-seen move in the currency has startled and struck many traders and

hedgers in Indian commodities markets.

Interest Rate DifferentialsWhile the Indian monetary authority has been hiking rates, the developed economies have not been

doing so at the same pace. Over and above this, the monetary tightening through CRR hikes took up

banks lending rates further up, adding significantly to the cost of borrowings in INR. Thus, the ratedifferential between domestic markets and overseas markets such those of US and Japan widened

considerably. The active swap markets offered by Indian banks makes it possible for corporates toborrow overseas (ECBs) and thus swap it to rupees at an effective interest cost significantly lower than

local costs. This practice has being growing rapidly and created huge inflows of USD into the Indian

markets. This has not been a new phenomenon. Whats different this time is that RBI has completely

stayed out of the market to absorb these dollars. As a result of this, we have only sellers of dollars in themarket.

FDI and FII FlowsOwing to the vibrant state of the domestic economy and the stock markets, we have also witnessed aspate of inflows from these two sources. NRI remittances have been sizeable as well.

Monetary Policy tighteningThe Monetary Policy of recent months strived to tighten money supply by hiking reserves requirements

along with raising interest rates. However, this has instead induced overseas funds to flush our marketsand counter all tightening measures of the RBI. We must appreciate the fact that Indias financial

markets are now highly integrated to global markets and the doors for entry and exit of funds is much

larger in size.

Purely Domestic StoryIt is important to note that this move in INR has not been part of any broader global or Asian theme. TheINR appreciation has been strictly an isolated case. In the past, whenever the INR has made big moves

on its own, they have been for its weakening. This time it has been on the strengthening side and one

with a historic magnitude.

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Commodities The Disconnect

Performance of some of the most active global commodities vis- vis on the local exchanges.

Looking Ahead.

The recent appreciation has been unprecedented and is considered extreme if seen in historical

perspective. Whether, the INR pulls back to the 44 / 45 levels or not is not really what were looking

forward to but the fact that the current level of the INR is most likely to be sustain for another 2-3months. The year 2007 will most likely be a year of Rupee strength. However, in the near term, the INR

expected to touch 40 and remain stable at 41 /42 levels till September 2007.