Appreciation bias for Rupee to persist

The rupee finished its best quarter since 2009, as it appreciated over 1% last week, adding to its sharp gains over recent weeks.

The Indian unit has been turbocharged by the recent reform measures by the government despite growing political opposition. Investor enthusiasm towards the rupee-denominated assets has increased, with foreign institutional investors (FIIs) buying $1.8 billion worth of stocks and bonds last week, taking their total purchases in September to $3.7 billion.

With three major global central banks -- US Federal Reserve, European Central Bank (ECB) and Bank of Japan – easing global liquidity conditions further, investor appetite for risk improved over the month. That saw funds flowing into riskier asset classes, from equities to commodities. This provided a supportive global backdrop for the government measures to enhance flow of foreign capital into India.

Last week, the government announced restructuring of the debt of state electricity boards, taking a step towards tackling the supply bottlenecks facing the economy from the power sector.

The package represents the second bailout since 2001 and is expected to extend a temporary lifeline to the power sector, which is characterised by underinvestment and, as a result, under-supply. This further helped boost investor sentiment towards the Indian economy. Moreover, the government not increasing the size of its borrowings for the second half of the fiscal for now has also helped allay fears of fiscal deficit rising sharply.

More pertinent information for the exchange rate of the rupee was also released last week by the Reserve Bank of India (RBI) in the form of Balance of Payments (BoP) data for the first quarter of the current fiscal. The BoP registered a small surplus after two successive quarters of large deficits, indicating that after driving sharp rupee depreciation of over the second half of the previous financial year, trade and capital flows were now signalling a stable exchange rate for the rupee. The current account deficit came in lower than the previous quarter as non-oil imports shrunk on slowing growth and falling demand for gold, even as exports fell on weak global economy.

Measures taken by the RBI to boost the flow of capital into the country yielded desired results, especially in the case of NRI deposits where inflows were boosted by interest rate deregulation on these deposits. Going ahead, even as current account deficit remains higher than a sustainable level of 2.5% of GDP, improved inflow of capital, particularly portfolio inflows, would help fund the gap.

Local market participants have seen significant action in the rupee-dollar pair over the last three weeks, and would be looking for signals both from the government and the euro zone to drive the rally further.

Concerns over Spain were the driving force of risk appetite throughout last week. Rising tensions in Spain where protests broke out earlier in the week against austerity measures, saw investors turning risk averse. The euro fell against the greenback after US purchasing managers’ data and consumer sentiment trailed forecasts, crimping demand for riskier assets.

However, the market sentiment appeared to be calm as Spanish government announced further tax hikes and spending cuts as part of its 2013 budget, which were widely viewed as paving the way towards meeting the likely conditions that would come with accepting a sovereign bailout.

The euro saw a relief rally after the Spanish budget announcement. The euro also gained after a report on Friday indicated that the Spanish banking sector needed an injection of nearly €60 billion to meet capital requirements, a figure that was in line with market expectations.

Asian currencies had the best quarter in two years after the global central banks announced plans to pump money into financial markets to support growth, spurring capital flows into higher-yielding assets. Global investors pumped $9 billion into the stock markets of India, Indonesia, South Korea and Taiwan in September. Asian currencies gained further on Friday after Spain approved its austerity budget, boosting optimism Europe is moving toward resolving its debt crisis.

Chinese yuan surged to its highest level against the greenback since 1993. The yuan strengthened on speculation that the government will step up efforts to halt a slowdown in the world’s second-largest economy.

On the economic calendar this week, the monetary policy announcement from the ECB and the US non-farm payrolls data are the most the most crucial.

Market participants are hoping that the European policymakers will supplement debt crisis containment efforts with measures to bolster economic growth. If the ECB does not provide any stimulus, then risk appetite will be affected adversely, helping the greenback in the process. The US non-farm payrolls data would have to be watched carefully, as the Fed under the third round of quantitative easing has committed to buying bonds every month.

In the local market, the rupee can continue to trade with an appreciation bias after three straight weeks of gains have changed the market momentum in its favour. Any measures from the government to support growth or curb its fiscal deficit, could see rupee appreciating towards the 51.50 - 52.00 range against the US dollar. Also, any positive news around an economic bailout for Spain could boost global investor risk appetite and help the rupee gain further.

The writer is senior economist, Royal Bank of Scotland N.V. Views are personal.
E-mail: gaurav.kapur@rbs.com