Decoding The Impact Of The Yen Carry Trade Episode On Indian Markets
In this discussion, three financial experts - Paras Jasrai, Kunal Sodhani, and Anindya Banerjee dissect the impact of the yen carry trade on India's economy.
The yen carry trade has become a significant factor in shaping the dynamics of global financial markets, and its impact on Indian markets has drawn considerable attention from investors and analysts alike. As Japan's ultra-low interest rates persist, investors are increasingly borrowing in yen to invest in higher-yielding assets, including those in emerging markets like India.
The recent hike in interest rates set off a significant chain reaction in global financial markets. The Japanese yen, which had been weakening due to Japan's persistently low-interest rates relative to other major currencies, suddenly appreciated in value. This unexpected strengthening of the yen caught many investors off guard, leading to a rapid sell-off of Japanese assets. Japan's Nikkei 225 index was particularly hard hit, plunging over 20% from its peak and officially entering bear market territory. The shockwaves from Japan extended across other Asian markets too.
In India, the Sensex dropped by 2.74%, while the Nifty 50 fell by 2.68% on August 5. Moreover, according to Elara Capital, India’s yen-denominated assets have seen a substantial increase, surging from $6 billion in January 2023 to nearly $21 billion by the end of June. This accounts for approximately 2.2% of the total Foreign Institutional Investor (FII) holdings in India, which amount to $945 billion. This influx of yen-denominated investments highlights the growing influence of the yen carry trade on Indian markets, adding a new dimension to the country's financial landscape.
In this discussion, three financial experts - Paras Jasrai, Senior Analyst and Economist at India Ratings & Research, Kunal Sodhani, Vice President at Shinhan Bank and finally, Anindya Banerjee, Head Research and Currency Commodities at Kotak Securities dissect the impact of these developments on India's economy. They address crucial aspects like the potential long-term effects on India's financial stability, Indian equities' reaction to the increased foreign capital and risks that could arise if the yen continues to appreciate or if Japan adjusts its monetary policy.
Edited Excerpts:
Kunal, let me begin with you. Tell us about the yen carry trade and why this suddenly played such an important role or suddenly managed to start moving capital markets worldwide in the last week.
Kunal Sodhani: First of all, first important basics of carry trade means, to make it very simple– it's like borrowing maybe at a lower interest rate or a negligible interest rate. So if we talk about Japan, historically, Japan was into negative interest rates, or you can say a flattish interest rate where people used to borrow from Japan and invest into high yielding assets. Like, for example, equities globally or maybe high yielding bonds globally. So since several years, maybe since 1987, this carry trade has been happening, but the interest rates have been negative to maybe zero. So obviously, when interest rates are negative or flattish, you are borrowing almost free, where you don't have to pay any interest outlay on the loan. Things were going very smoothly, and the currency was also not that volatile. If we talk about historical data, we had these negative interest rates mainly to spur growth into the system and inflationary trajectory to increase more into the system. But after a lot of data points from the jobs as well as from the wages point of view, Japan realised that it's time to hike rates. And thus this was for the first time, I think after 17 years they hiked rates, I think 0.1% to 0.25%. So that's the band which they have hiked to. But if you talk about the last five months, it's been almost a 35 basis of hike. So I would not consider this as only a hike. So we should see a 35 basis of hike in the last five months. Now, what is happening?
Once your interest rates are hiked, obviously your interest outflow for the loan goes higher. And once you raise an interest rate, your currency also starts appreciating, which means the dollar yen pair, JPY started appreciating. Now, as an investor, when I'm putting money, borrowing at almost at negligible interest rates, first, my interest outflow is higher. Secondly, wherever I'm investing, I am also getting a currency risk. And now because after the rate hike, when it is starting to appreciate, it is also hitting me. So I am getting hit as an investor from two sides. One is rates and second is currency. Now, once I saw the currency that is a dollar-yen pair moving from 162 to almost 141.60, which clearly states that there was an urgency of letting off of flows. Till now we were only talking about carry trade. Now it's also important what exactly is happening now and why there was a sell off.
As I discussed, the interest outlay got increased plus MTM started increase wherever I was investing as a Japanese investor, or any investor who had borrowed in Japanese yen or Japanese currency at Japanese interest rates, I started in getting the MTM calls because I need to pay back on the depreciation which happened on the dollar-yen pair. That is, the appreciation of the JPY. Plus the interest outflow was higher.
Can you illustrate that? I'm assuming you're talking about mark to market. Give us an example of, let's say brokerage or a financial institution has bought 100 shares of something, then if you could illustrate that, that would help.
Kunal Sodhani: So basically, if I have borrowed something at 0%, assuming on Rs 1,000, just an example for understanding then obviously my interest outflow is zero. There's no interest outflow to me as someone who has borrowed Rs 1,000 from the market.
Now this interest payment has got an increase of, assuming 1%. So obviously I have to pay 1% on Rs 1000 as my interest outflow. That's my first outflow, which was never an outflow to me ever. Now secondly, when I borrowed that Rs 100, that was at a particular rate. So assuming if I talk about conversion of dollar into rupee or JPY into rupee, I had borrowed that at some particular rate, assuming 85, if I talk about dollar rupee.
Now, if I see an appreciation in rupee, you know, the value of that 85 going to 80 has now got lower. So the INR amount which I had in the system at 85 was higher and now it has gone to 80. So I am getting an impact on two ways, as an example, because I have to pay more interest. Plus the value of the rupee which I had has also gone down because the dollar rupee rate has gone down. So this is a simple example of it from both sides.
Let me come to you Paras. So how are you seeing this whole currency turmoil that we've seen in the last few weeks?
Paras Jasrai: So if you see from the macro perspective, there have been like key movements in the stock market where there was a certain outflow quite significantly higher during the 5th and 6th August. And that had a hit on not only the US and the Japanese markets, but also in the emerging markets specifically for us as well.
So that basically led to a higher amount of equity flows and as a result, our currency was also under pressure and we had depreciated to a record low at about like 83.7 or above that. So in the sense of how the overall financial flows are moving out, especially from advanced central banks such as Japan and US, etc., they have a very close linkage that is playing. And we are also quite, very in sync with that and that's why that had a hit overall, our currency as well; where there was a high equity outflow and that led to broadly a very sharp depreciation for us.
But if you compare with other economies, then it was like, not that, I mean, it was broadly managed. And the reason for that was that we have a very high forex reserve, which basically means that the central bank has the ability to intervene in the market to control any excessive volatility. That is something that we saw this Monday.
Ainindya, my question to you is, we've seen a very eventful week in currency, particularly with the yen carry trade and the unwinding of it influencing the capital markets elsewhere. When you look back, what was the last time that you remember when currency itself had such an impact on global markets?
Anindya Banerjee: In fact, in the last 20 years I've been in the financial markets, I've seen the yen carry trade unwind several times. The first one I experienced was way back in 2004, and we had a huge crash in the equity markets. Then 2006, 2007-08 we all know, the global financial crisis. And then it was the Chinese-led thing which happened in 2015-16, I think that was the last major episode of the yen carry trade unwind. 2020 was not really that one. So after 2015-16, I think this is the next major one.
So we have a sense of why this happened. And Kunal was explaining to us the whole mechanics behind how people borrowed in yen, because obviously it was zero interest and then use that money to invest elsewhere and thus earn higher returns. But my question is yen the only currency where this happens, or has happened in the past and therefore caused such, let's say, impact on other markets?
Anindya Banerjee: In fact, this time around, I think along with the yen carry trade, a bit of yuan carry trade was also there. That's why, interestingly, on those two, three days when the yen was appreciating, yuan was also following. So yuan, you don't get to see a lot of people borrowing in yuan, funding their speculative trades.
But what happens is that the local Chinese, they were expecting a big depreciation of their own currency; that didn't come through. So in order to hedge their expected depreciation, they started to buy a lot of commodities. I don't know, maybe they loaded up on equities as well, but definitely commodities. So that's the reason why the yuan carry trade unwind had a negative impact on the commodities as well, along with the yen carry trade having an impact on the equities.
So my next question is on the magnitude. So let's say the yen carry trade, the unwinding happened, which is that people started selling off because they had to pay more in terms of interest. Have we seen instances of this magnitude in the past as well?
Anindya Banerjee: Yes, because the common feature in all those episodes is that, as long as they last, they don't last for long, maybe one, two weeks. But it's brutal because what happens is the margin calls are triggered. You have to sell not because you want to sell, but what you have to sell. It's pure leverage unwinding. So we have seen a bit of that this time around. It has been far short lived than what it used to be in the past. But, yeah, we have seen such kind of brutal moves in the market.
And to that extent,this is a slightly broader question, and I'm going to come to our other guests as well. Is this something that people keep in mind that, you know, somewhere in one corner of the world in Japan, there is a position that's building up. And people have taken cheap loans using that money to invest somewhere. And someday that could suddenly reverse, and therefore it could have all of this impact.
Anindya Banerjee: Right. This time around, the impact has been little sharp because people were expecting the Bank of Japan would be the last one to hike rates, and especially when every other central bank has gone from the hiking cycle to the now cutting cycle. So the Bank of Japan, though they hiked it, they may not hike again, but they surprised the entire market by hiking the rates this time. And that led to the unwinding. So people were unprepared.
Okay, how do you see this, Kunal? I'm saying now, the specific action, the surprise part of it, is that something that currency markets you were at all suspecting, or was it a complete shock from your vantage point?
Kunal Sodhani: So I think two things which I want to highlight.
First, if we see the statistics. So according to the Bank for International Settlements, first, how much was the cross border loans which were given in yen? So, if we talk about the data, the data is $1 trillion, which means roughly around ¥ 150 trillion, if I'm not wrong. So, I mean, in 2001 and in 2024, this has increased by almost 21%. So obviously the magnitude has to be higher.
And personally, I believe that the complete unwinding is still not done because as Anindya rightly highlighted, that it's a process, it's not a three-day event, that, okay, one fine day, things happened, now I've unwounded and everything is done. Also, just to add on to the Chinese yuan part, yes, we did see an appreciation towards almost… the offshore yuan went to 7.08 levels.
But I would not say that China and Japan are similar stories. Because China has its own capital controls, the currency is also managed. It's not a free float where, you know, there can be a huge movement and it cannot be inter-window controlled within the price band by the Chinese yuan. So I don't think much of an impact from that side. They have their own economic problems, which is not related to the global scenarios which are heading now.
But yes, there can be some element of risk, which obviously for rupee, it makes a lot of difference because our exports are compared to China to a large extent. And obviously, when the Chinese yuan weakens, the rupee also starts to tend to weakening. It's like a mirror image. If you see a dollar-INR chart or a Chinese yuan chart, it reflects on that way.
What I mean is the unwinding possibly is not yet over. My personal belief is yes, it's kind of a short trap. Possibly at this point in time we may see some hike in the dollar JPY pair towards 151-152. But in case, even the deputy governor's comment of Japan that they may not hike the possibility of Fed cutting rates aggressive will also cause unwinding because ultimately the interest rate differential there will further narrow. And if they narrow, the unwinding will again take into consideration. So irrespective, Japan doesn't do anything, and if there are aggressive cuts from the Fed, that may create furthermore unwinding. That's my personal take.
Sure. Anindya, what's your sense on, and I'm going to come back to all of you on this as well. So now as we look at India and the rupee, and before we come to that, how have we been faring vis a vis the rest of the region when it comes to, let's say, the movement or behaviour?
Anindya Banerjee: So over the past one month or so, we have been a laggard. But overall, if you look at on our volatility count, because there are two ways to assess the performance of the Indian rupee. One is volatility, or rather the relative volatility. And the other one is of course, how much has the Indian rupee done against the other currencies? So other currencies, we have been a laggard of late because a lot of the emerging market currencies, especially in the Asian bloc, had appreciated with the yen, so we did not.
But in terms of volatility, we are like the gold standard at this point in time because we are almost not volatile at all. Some people are even thinking it's pegged. So that is what has been the central focus of the central bank, the RBI, and they have been able to ensure that happens quite well. So, we have been a laggard, but extremely low volatile.
Okay, Paras, any thoughts from you on this?
Paras Jasrai: Yeah, so if you see since the last one year or so, if you compare from a long term perspective, not the short term one, then as Anindya mentioned, that the volatility which in quantification terms measured by how the overall year-on-year depreciation for the rupee has been, and if you compare with the other emerging economies, then it definitely is very, very managed. In fact, since September 2023, the rupee has been very, very…. moving around 83 and moving in that range. And earlier it used to be said that RBI is managing the float where the rupee was allowed to have some movement, and there was a flexible exchange rate as well.
But currently, there's certainly the peg, the central bank wants the overall currency to move for a very gradual period of time, not in a very sharp fluctuation… They want to see. And that's what I mean, the data is reflecting about. And there's another point, is that the overall reserves are something which give the central bank more control and that has been the case compared to other economies.
Right. And we've now hit about $675 billion as of August 2, which is also high. Just to come back to you, Kunal, the JP Morgan Chase has put out a note saying that they believe that 75% of carry trades have been unwound, implying that only 25% is left. But that's their point of view. Any thoughts on this in terms of how much is still lurking or how much is already unwound?
Kunal Sodhani: I'll be very honest. I think to put that into a number will be difficult because ultimately no one actually knows that. Even as we discussed that even if the cross border loans are 1 trillion, how many of it are actually into the riskier assets… to define that, possibly may be difficult, but I personally feel that it is maybe still around 50% and not 75%. That's my personal take.
Because there still remains a lot of bigger hedge funds who are ready to hold on because they know that some spike may be seen in the interim where they can get a better exit. So I feel around 50%. I think 50% is still yet to go.
Let's come back to the rupee now. Anindya, so the rupee has been under pressure. We are seeing record lows week after week and it has now fallen for the 6th consecutive week. And we hit a record low of Rs 83.97 on Wednesday.
So I have two parts to this question. So one is what is putting the pressure right now apart from the fact that we are managing it and it's all moving in a band. And secondly, 84 seems to be a bit of a concern point. It's almost the psychological panic point. Not a major panic, but a minor panic. Would you agree? And if so, also why is this happening?
Anindya Banerjee: Yes. The one factor which has played out in the market is that RBI has been continuously intervening in the market to accumulate reserves. Now, it's hard to say what is the milestone of RBI, but sometimes, if you consider some of the speeches of the governors, they tend to talk about the external debt, which is low on the private balance sheet. But they tend to benchmark the FX reserve as a percentage of the external debt. And considering that the external debt is rising, they have continuously accumulated the FX reserves. So that is a major factor.
And secondly, with the exchange traded market now offline, what has happened, a lot of the speculative flows, which used to come both from the onshore as well as through the offshore, that has completely gone, or at least, at least a large part of the offshore is gone. And the onshore speculative trades are largely gone. So what you have is largely players who are commercial in nature, exporters, importers and the market makers, the banks who are quoting to them.
When you say that the speculators have gone away, why has that happened?
Anindya Banerjee: There has been a change of regulation around April onwards. A circular had come out in January stating that only export is an importer. Somebody with an underlying can take positions on exchanges in USD and other rupee pairs. So that's the reason why we have seen the entire speculative community move out. And that's why this market has become very homogeneous in that sense. So whenever there is a large demand, be it RBI or be it an importer, it tends to push us higher. And also if you see the trade deficit has been increasing, so which means on a net basis we are… the dollar demand is increasing gradually.
So if you consider the change of how the market has changed and with the increasing trade deficit and RBI's intervention to accumulate reserves, all these three factors have led to a situation where we see a gradual drift upwards in the market. Because there have been no big outflows from India. The Indian equity markets have been doing well, FPIs have been reluctant to participate, but their incremental flows are there even in the debt as well.
Is speculation a good thing or not a good thing? I mean, if in the stock markets, for example, if you took away speculation, you would not have price discovery, isn't it?
Anindya Banerjee: Right. Actually what happens is that the three parts of the market are important to create a vibrant market. But currency is very different from equities because currency has a huge economic implication. It is not just like playing in the stock market. So that's the reason why RBI had taken a more holistic view of things and they had taken this call. So based on this, we have seen this impact on the prices.
Kunal, what's your sense? So why is the rupee under so much pressure right now? Despite the fact that we are at such high inflows and other macroeconomic factors looking reasonably stable, or at least nothing has changed dramatically.
Kunal Sodhani: So firstly, if you talk about in terms of numbers, I think the August flows for equities have been to the tune of negative Rs 13,000 crores. But on the debt front we have got decent inflows roughly to the tune of Rs 35,000 crores for the month of August. So obviously flows are not the only factor, but there is something know as a sentimental impact. Plus the Middle East crisis also triggered in between, though it had a very smaller impact. I mean, obviously the Japanese unwinding had a larger impact on the markets, but obviously such outflow of money was seen.
If we see the numbers off late, it's the DIIs who are actually supporting the market to a very large extent, or the SIP flows. But FPI money is more of a hot money where it comes and goes. So even if a three or four day outflow is seen, some kind of impact can be seen on the rupee.
One, because the rupee is not a very liquid currency also. Like it's not a very developed currency where a 500 or a 1 billion flow will not have any impact on rupee. So liquidity is one concern is what I feel. Secondly ,also if we see the FED rate cut aggressiveness, where we are seeing the forward premiums to start rising again.
So if I remember, I think the last numbers maybe 15 days back was around 1.59% one year premium which has gone to above 2% now. So I think some kind of importer demand is also seen in the market at this point in time, which are also somewhere pushing in terms of uncertain times to come. So these two are important factors.
And third is obviously, as everyone thinks, that it's a managed currency to some extent, I would not say completely. So RBI also tries to maintain a certain band, not eyeing a particular number in place, but at least they know the importer exporter where their comfort level is. If I talk to a lot of clients as a sales guy or as a dealer or as an interbank guy, no one is thinking that 83 or 84 are bothering them at this point in time, because there is a lack of volatility.
A band of 83 or 84.5 is also an importer is also comfortable and an exporter is also comfortable. So somewhere that panic, I would not see that there is there into the market somewhere that creates a lot of problems. A demand supply mismatch at times is seen. I think that's particularly the main reasons.
Also, last thing, as we rightly highlighted that we have $675 billion of FX reserves. But out of $675 billion, it's also important that what is the FCA, that is the foreign currency asset component, which is almost 88% of the entire forex reserves. So what does FCA mean? Foreign currency assets are nothing but non US units or non US currency which are getting appreciated or depreciated based on which this number comes. So intervention is one part, but it's not a massive part of the dollar reserve or the FX reserves rising into our country.
Paras, if I can just get a quick macro take before we go back to currency, what happens when, let's say, the rupee goes closer to 84 or beyond? I mean, what's your sense on how it affects importers and exporters? I know it affects exporters positively. But what's your sense in a more macro kind of way?
Paras Jasrai: If you look at a long term perspective, then overall rupee depreciation broadly has been about 3.5% during FY20-24. And in fact, in the last financial year, it was about 3% depreciation that we had seen. So our view, in-house view was also that broadly, the rupee would depreciate about 2.3% this financial year. And by FY25, we expect it to be hitting on an average 84.7… I mean, the lower depreciation this year would be due to the fact that JP Morgan inclusion and the Bloomberg inclusion in January is also slated. So that will also help in reducing the depreciation. But yeah, I mean, overall, expect the depreciation to be there because that's the overall trend that the rupee has.
Anindya, is that, I know you've been saying the same thing for some time too, but are you still holding the view that we will continue to see this very slight, but maybe managed depreciation?
Anindya Banerjee: Yes, because as I said, I think that RBI is targeting the external debt as a benchmark.
And it was in fact mentioned quite clearly in the Bimal Jalan committee report, which was, if you remember, it was released... I think before COVID. So that committee report clearly mentioned that RBI should target the external debt as a benchmark on which the FX reserve should be increased or decreased.
So with the external debt rising and expected to be so, I think that we will continue to see RBI coming in and building the FX reserves. But at the same time, RBI is clear that volatility has to be low. They have been quite successful in that because you see over the last 10, 15 years, what has changed with the RBI is, it used to be like a fire brigade. They would come in when there is a fire. Then they have become almost like a daily player in the market. And now they're like a market maker, right? So that allows the RBI to churn its reserves and also keep the volatility down. It's a win-win situation. So I don't think that FX policy is going to change at all over the next couple of years.
We started by talking about currency itself and the fact that it's suddenly playing a very important role or played an important role at least last week in our lives, particularly if we are in financial markets and anywhere in the world. And of course, India has been affected. India has also been affected in a way because we are seeing considerable pressure on the rupee by the dollar. So that was the background.
So my forward question and really the last question to all of you, as you look ahead, what's your sense of how we should be reacting or not reacting to a relatively weaker currency? Is that something that we should be comfortable with? If not, what should we be doing? And if we are comfortable, then how should we be treating it? Paras, you first.
Paras Jasrai: So our view is that, I mean, if you look at the fundamentals of the Indian economy, then they are pretty strong. But if you look on the export side of things, then exports have picked up somewhat. But even if you look at the latest numbers, they show that growth has been very tepid about 2% year-on- year. And if you look at the real sector exchange rate, which basically, in other words, means how the overall exchange rate is panning out, adjusting for inflation and also affecting all the trade partners that are there. So as of now, currently rupees is overvalued by about 6.5%.
That basically means that that is hurting export competitiveness. And rupee depreciation is something which needs, I mean, exporters need to have that sort of competitiveness too in order to,...for our exports also to be growing in a healthy manner, which is in sync with the overall domestic fundamentals, which are strong.
Kunal, how are you seeing, you know, also, I mean, are we sufficiently alert now that we've seen this sudden event triggered by the Japanese yen? If so, how should we be looking at currency in general and what we've seen in India in the last week or so?
Kunal Sodhani: So first of all, if I talk about the political stability which India holds, it itself speaks a lot about the flows which we are attracting. So that's the first point. But secondly, if we talk about the FDI flows, which people are not talking much about, they are at decadal lows. You know, we are talking mainly about the FPI flows. And as I discussed that those are hot money, you know, it takes five good days and everything may be washed out. But FDI flows is something which is a lot of cause of concern, at least from my point of view.
Secondly, it's about the rate trajectory from here, because that may define a lot of differences in terms of liquidity, in terms of the demand and supply and the interest rate differential going ahead and the depreciation phase of rupee. So for me, I think if I put that into numbers, first, I'll talk about the dollar index, because in case if we are seeing an aggressive cut, then possibly the dollar index may appreciate further, where we may see levels of 180-102 levels. While if I put that on the resistance front, then 106.50 holds is a very strong support or a resistance at this point in time.
While if I put that into the yields perspective, you know, we have seen yields dropping to almost 3.65, 3.7%, the 10-year US treasury yields, though they have bounced back near 4%. But I think pressure on yields may also persist with time. So to sum it up into dollar-rupee pair and what my take would be, I think we see a very good base at around 83.60 to 83.80 band, that's a good decent base of formation where RBI may also come into picture to increase the reserves following, obviously, the external debt, as well as, you know, when you have inflows around… if you talk about last year, we had almost 1.7 lakh crores of inflows.
Similarly, even now inflows are decent enough. So without much depreciation of rupee when you are able to absorb more reserves, which is a good sign. So slow steady depreciation may be seen. I don't see a sharp depreciation, but at least if you talk in numbers, then 84.50 is what I find as a major resistance point at this point.
So Anindya, last question and word to you. So how should one be looking at currency in a very broad sense, global and then, of course, Indian? And how should one gear oneself as an enterprise, as a CFO, as an analyst, particularly in the coming months?
Anindya Banerjee: See, internally, because Indian rupee is always the interplay of what's happening domestically and what's happening abroad. Domestically, the macros are strong. The inflation is under control. The growth is impressive. As Kunal said, the FDI flows have been low. And that is concerning because the global situation is not that great. Yes, America is still doing fine.
The reflation trade may begin because every other central bank is talking about the rate cut, except for the Bank of Japan. But at the same time, the largest emerging market economy, China, is in big trouble. So we don't know how that plays out from time to time. So which means globally, the volatility is going to be there. And RBI is very much aware of it. And that's the reason why they will not waste any opportunity to build reserves. Because any moment, some risk may come. There has been a lot of talk about this overvaluation in the US tech sector. And now you have the carry trade thing. So from time to time, such episodes will come. And then we have the US elections which means that 83.5, yes, is a strong base. And on the upside, we'll see a gradual depreciation on the Indian rupee.
As long as it's gradual, I don't think the company won't mind. Because what really hits the exporters and the importers is the volatility. Because when the volatility increases, it's very hard to factor that in your budgeting, your cost budgeting, your exports, etc. So as long as the volatility is going to be low, which I think RBI will ensure… So I don't think the currency will pose any serious challenge to the corporates.
