Budget key to Re’s fortunes

Financial markets began the second half of 2009 nervously after signs that economic recovery, which was seen around the corner, may be some time away.

The change in sentiment followed non-farm payrolls report on the US labour market on Thursday, which showed that there were 4,67,000 jobs losses in June, much more than the 3,50,000 expected. After several months of the rate of job losses slowing, the June data came as big disappointment and the “green shoots” scenario was severely dented as a result.

This dealt a blow to the already fragile risk appetite of market participants.
The US dollar received a boost after investors became a little more uncertain about the global economy and opted for safe-haven assets. The trade-weighted dollar index — a measure of the US currency against a basket of other units — jumped 1.1% on Thursday. Over the week, the index was up 0.5%.

Carry trades were unwound as appetite for risk waned. This weakened the New Zealand and Australian dollars, which are among the highest yielding leading global currencies. The A$ fell 1.3% over the week against the US dollar and lost 0.4% versus the yen. The Kiwi unit lost 1.9% and 1% against the greenback and the yen respectively.

Another key event of the week was the meeting of the governing council of the European Central Bank (ECB) on Thursday. The ECB left its main rate at 1% but president Jean-Claude Trichet indicated that this was not necessarily its lowest level. Given the widely expected outcome of no change in monetary policy, the ECB decision had little impact on the euro, which fell 0.6% over the week against the US dollar.

The other European major, the pound, weakened last week. It was undermined by weaker-than-expected domestic data that showed business activity in UK’s services sector dropped in June, the first fall in 7 months. Pound fell 0.8% against the euro and lost 1.1% on the US dollar.

Among other important developments last week, Sweden’s central bank surprised the market with a quarter-point rate cut to 0.25% and added that it would offer loans totaling SKr100 billion ($12.8 billion) to the country’s banks at a fixed rate over the next year. The Swedish krona’s strong run was interrupted as a result and the currency fell 1.5% versus the euro after Thursday’s decision. The Krona however, finished 0.4% stronger over the week.

South Africa’s rand had a mixed week, initially advancing its claim as the year’s best-performing currency. The rand rose 23% against the dollar in the first half of 2009, boosted by higher commodity prices and its relatively high yield. But as markets became more risk-averse on Wednesday, the currency fell back and ended the week little changed.

In the local inter-bank market, the rupee finished the week stronger against the US dollar, helped by gains in local equity market and dollar inflows from QIP proceeds. The rupee-dollar pair traded in the range of 47.74-48.26 over the week.

The RBI released the balance of payments (BoP) data for the quarter ended March 2009 on Tuesday. The data was broadly positive for the rupee as it showed improvement in the external fundamentals of the economy. The current account, which accounts for trade in goods and services, registered a surplus of $4.7 billion after two years of deficit, helped by a sharp slide in oil prices during the quarter.

However, key invisible receipts - software exports and private remittances - registered lower net inflows compared to the same quarter of 2008, highlighting the risks to the rupee from the slowdown in invisible receipts.

The other positive highlight of the BoP data was a pick-up in capital inflows during the quarter. As a result, the overall BoP was in a surplus of $0.3 billion compared to a deficit of $17.88 billion.

Any improvement in the BoP, especially on the back of a pick-up in capital inflows, would be helpful in providing support to the rupee in the current fiscal. Current account could, however, remain in deficit, almost as big as the previous fiscal, thereby maintaining some pressure on the Indian unit.

Last week also saw the release of the finance ministry’s economic survey ahead of the Union Budget announcement on July 6. The survey indicated that the economy could grow around 7% in the current fiscal, if the US economy bottoms out by September, and could return to 8.5-9% growth in medium term, if reforms are pursued.

The survey made policy proposals for fiscal consolidation through tax reforms and rationalisation of subsidies, reforms in the financial sector to enable greater domestic resource mobilisation and improvement in the investment climate of the country. Some of the survey proposals could form a part of the Union Budget.

Overall the survey reiterated the confidence Indian policy makers have shown in the prospects of the economy in recent months and was received positively by the market.
This week the most important event on the Indian policy calendar - the Union Budget — is due.

The Budget also assumes a lot of significance, considering that market participants and foreign investors are hoping that the new government would initiate the second round of reforms, which could enable higher levels of economic growth on a sustainable basis.

The most important challenge the central government faces is on the public finances front, given that the fiscal deficit is likely to exceed 6% of GDP this year. Therefore, any proposals to shore up non-tax revenue through disinvestments and new timelines for reducing the fiscal deficit would cheer the market.

From the perspective of the rupee, measures to improve investment climate in the country in order to attract greater foreign capital, would be positive.

From overall market’s perspective fiscal consolidation and commitment to economic reforms would be the key things to watch out for. Any lack of clarity and possibility of delays would disappoint the market. The rupee-dollar pair can trade in the range of 47.40-48.00 this week. Positive and concrete budget proposals aimed towards shoring long-term growth prospects could push the rupee-dollar pair into a new range.

The author is senior economist, ABN Amro Bank. Views expressed herein are personal.