A strange and risky picture: Why it is much more difficult to manage USD-Rupee risk as compared to EUR-USD - The Financial Express

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It is well known that the rupee, at the best of times, is an odd bird. Even though the domestic USD/INR market is now reasonably liquid, albeit less so than about 10 years ago, the pattern of rupee movements is a far cry from the near-normal distribution that most liquid currencies exhibit.

The accompanying graphic shows the distribution of 12-month returns of the spot rupee since 2003. On the left-hand side of the accompanying graphic is the percentage of times (counted on the y-axis) that the rupee appreciated; the x-axis shows the degree of appreciation (in percentage terms); the right-hand side shows the periods of rupee depreciation.

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The rupee depreciated 61% of the time—in a closer-to-normal scenario, it should depreciate only a little more (or less) than 50%. What is particularly odd, as the accompanying graphic shows, is that the rupee’s most likely performance was a 3-4% appreciation over 12 months, which event occurred more than 20% of the time over the past 17 years. In more liquid currencies, the most likely performance is within a range of -0.5% to 0.5%. In EUR/USD, for instance, the 12-month returns were in that range 56.5% of the time; in the case of the rupee, it was just 17%.

There could be several reasons for this departure from normalcy—first off, the NDF market has a strong influence on the price (which RBI is trying to address); secondly, and quite obviously, there are far too many constraints on market access (no convertibility); and, finally, of course, RBI is largely in, or threatening to be in, the market all of the time. These forces limit the markets ability to develop its “normal” tendencies.