Reforms push to keep the bias +ve for Rupee

Focus in the financial markets shifted back to soft economic data from China, Europe and the generally weakening health of the global economy as optimism created by the third round of quantitative easing by the US Federal Reserve faded. Worries about the euro zone sovereign debt resurfaced, with uncertainty about whether Spain will ask for another bailout kept market participants wary.

In the currency market, most major currencies remained weaker against the US dollar, as the optimism following the Fed’s decision to implement a third round of monetary easing gradually faded.

The euro fell for the first time in six weeks against the greenback, as reports showed that the region’s economy was struggling amid the debt crisis.

The Japanese yen advanced against all major currencies as weaker-than-forecast data from China and rising tensions between China and Japan spurred demand for safer assets. The yen reversed losses to rise against the US dollar in spite of the action taken by the Bank of Japan on Wednesday.

In the local market, the rupee continued to gain against the US dollar.Over the week, rupee appreciated by 1.5%, making it the best-performing currency in Asia. Any doubts about the government not following through with foreign direct investment (FDI) in multi-brand retail were assuaged when the government notified the rules for the opening of the sector to foreign retailers on Thursday.

This was considered a significant step forward especially as it came in despite a key ally withdrawing support from the UPA coalition in protest against the FDI measures and fuel price hike.

Rupee and stocks got a huge boost on Friday when the government slashed taxes on overseas borrowings by local companies, stepping up a policy revamp to revive capital inflows into the economy. The withholding tax — a levy on interest earned by overseas investors on foreign loans issued by Indian companies — was cut to 5% from 20% for a period of three years, effective July 1.

This move will have a favourable impact on the corporate sector, as it helps them borrow from overseas markets at much lower rates and would also allow for greater inflow of dollars into the economy. The appetite for dollar denominated bonds of Indian companies has increased among long-term foreign investors in the recent week as resumption of policy reforms could keep rating agencies from downgrading India’s rating.

In another sign of growing appetite of foreigner investors for Indian assets, foreign institutional investors (FIIs) poured in $1.6 billion into the local stocks and bonds over last week, pushing stocks prices up further.

Buoyant equity markets are good for the rupee too.

Earlier on Monday, the Reserve Bank of India (RBI) also provided some monetary stimulus in the form of a cash reserve ratio (CRR) cut, raising hopes that it would soon consider a rate cut, as government measures to control fiscal deficit are going to give the central bank some room to cut rates without stoking inflation.

With global oil prices now cooling off and with the rupee regaining some of its lost ground, there can be some easing of inflationary pressures in the near-term, creating room for the RBI to cut the policy rate.

The momentum provided to the rupee by policy reform measures can sustain this week too, as there are expectations that the government may allow greater foreign direct investment in some other sectors such as pharma, pension and insurance.

On the whole , the government’s new-found resolve to revive growth and curb its fiscal deficit would continue to help the rupee remain in favour.

Market participants would also be paying close attention to developments in the euro zone. The Spanish government announces its budget for 2013 this week. Spain is likely to announce fresh fiscal austerity measures. Many believe that the budget announcement represents the last step before a formal request for aid from the troika of the European Commission (ECB) and the IMF.

If Spanish government does ask for official aid, it would be taken as a positive sign by the markets.

The rupee could continue to trade with an appreciation bias, as global investors look for higher returns in the backdrop of coordinated monetary loosening by major global central banks. The rupee-dollar pair can head towards the 52.50 level in the near term.

Kapur is senior economist, Royal Bank of Scotland NV, and can be reached at gaurav.kapur@rbs.com.
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