Budget, oil crucial to drive rupee

The biggest policy event in India — the Union Budget for the next fiscal year is due on the Monday this week.

In the run up to the budget, growing concerns about inflation, especially in food, pressure on already rising interest from the government’s borrowing programme, stalled economic reforms and overall deterioration in the investment climate on account of governance and other issues have acted as dampener for the local stock market, FII investment and the rupee.

Market participants would therefore look out for efforts from the government to resume its economic reforms agenda, especially pertaining to subsidies, taxes and foreign investment. Moreover, any rationalisation of budget spending and subsequent fiscal consolidation would also be watched for closely.

Measures pertaining to raising productivity and investment in the farm sector would also draw market’s attention.

On foreign investment front, the finance ministry’s Economic Survey hinted at allowing foreign direct investment in multi-brand retail in order to help control inflation. This along with allowing greater foreign investment participation is some other sectors like insurance would prove positive for the rupee.

Overall, any sustained improvement in public finances, clearly defined measures to control inflation, particularly food inflation, and resumption of reforms would have a positive impact on the rupee. On the other hand, any populism in the budget would prove negative for the rupee.

Market participants would keep one eye out for the developments in Middle East and North Africa. Growing geo-political tensions in the oil rich region has already pushed up crude oil prices sharply above $100 per barrel mark, with production in Libya getting affected by the civil unrest. If the pressure on oil prices continues, the downward pressure on the rupee will mount in the near-term.

Otherwise, the general strength of the US dollar would also influence the rupee-dollar pair’s movements. The greenback has been drifting lower in recent weeks on the back of lack of fundamental support.

The focus this week will on the critical US non-farm payrolls report and other economic data releases. The payrolls report is one of the most market-moving reports across global financial markets and February’s result will be particularly significant given January’s sharply below-consensus jobs figure.

A busy week of economic event risk will shape expectations and force sharp short-term moves ahead of the employment data release on Friday. It will be critical to monitor financial market moves as the US dollar nears significant lows against major counterparts. Consensus forecasts call for a respectable 190,000 jobs gain during the month of February — consistent with expectations of substantial improvements on January’s clear disappointment.

Earlier in the week, market participants would focus on ISM Manufacturing, ADP Employment Change, Initial Jobless Claims, and ISM Services data to gauge the likelihood that February payrolls meet consensus forecasts. Uncertainty surrounding the future of US Federal Reserve monetary policy puts market attentions on whether a broader economic recovery will be enough to produce similar improvements in the domestic labour market.

The Fed has shown little urgency in withdrawing extraordinary monetary policy stimulus amid generally weak inflation and lacklustre jobs growth.

Controversial quantitative easing measures have been a major driving force behind US dollar weakness, and it could take a substantial shift in the Fed’s stance and rhetoric to force a sustained greenback recovery. In the absence of such a change, the greenback may need a broader shift in financial market risk appetite to drive a major reversal.

Market momentum will favour continued US dollar weaknessinto the week ahead. CFTC Commitment of Traders data shows that non-commercial traders (typically large speculators) remain heavily net-short the greenback.  It would likely take a material improvement in US economic data or a similarly large dip in investor risk appetite to force a substantive bounce in the greenback.

Over the week, the rupee-dollar pair can trade in the range of 45-45.75 with some weakening bias. Last week, rupee depreciated by about 0.3% against the US dollar after the pair traded in the range of 44.98-45.4925.

In the currency market last week, the Swiss franc and the Japanese Yen surged last week as escalating turmoil in Libya drove safe haven demand for both currencies. The Swiss and Japanese currencies advanced as surging oil prices and a resulting weak performance from global equities weighed on risk appetite.

The Swiss franc was the star performer, hitting a record high against the US dollar on Thursday, while the yen peaked just shy of the peak of Y79.70 it hit against the greenback in 1995.

The low-yielding US dollar failed to benefit from the rise in risk aversion, however. The greenback finished the week lower against almost all G10 counterparts, continuing its multi-month downtrend. A fairly disappointing revision to fourth quarter GDP capped a week of mixed data, which did not support the US dollar. The attraction of the greenback was undermined by low bond yields, record current account deficit and the huge US fiscal deficit. In marked contrast to the US, both Switzerland and Japan have strong current account surpluses.

Over the week, the Swiss franc rose 1.9% against the US dollar and climbed 2.7% against the pound. It advanced 1.5% against the euro. The yen climbed 1.6% against the greenback over the week.

Meanwhile, hawkish comments from European Central Bank officials supported the euro, lifting expectations of a near-term rise in interest rates in the region. Over the week, the single currency rose 0.4% against the US dollar and was 1.2% stronger against the pound.

Sterling gave back some of its recent strong gains, easing 0.8% against the US dollar as figures showed that the UK economy had contracted by more than forecast in the fourth quarter.

The writer is senior economist, Royal Bank of Scotland NV, and can be reached at gaurav.kapur@rbs.com . Views are personal.