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ShareThe Indian currency has lost 8.7% of its value against the US dollar over this period, with 2.4% of that loss coming last week itself. That puts the Indian rupee among the worst performing emerging market currency.
The rupee has been under strain during the current fiscal as external fundamentals of the economy have worsened significantly on the back of a spiral in commodity prices, particularly crude oil. The mood of risk aversion among global investors in the backdrop of the sub-prime losses-driven credit market crisis has pushed them into withdrawing from riskier asset classes, particularly in emerging markets. India has been at the forefront here, as inflation has risen to a 14-year high prompting the RBI to raise rates, thereby worsening the growth and returns outlook.
Thus on the one hand, the merchandise trade deficit has ballooned, with a 51% year-on-year increase in the first four months of the fiscal and on the other, capital inflows required to fund this deficit (or the supply of dollars) have slowed down sharply. For instance, cumulative foreign investment into India, both in the form of direct and portfolio investments, was $7.7 billion during April-July 2008. This compares with $20 billion over the same period last year. Thus, demand and supply imbalances have played against the rupee.
A sharp appreciation in the greenback overseas has provided fresh impetus to the rupee's slide. The US dollar has been strengthening since the end of July and made massive gains in value over the month of August. It has been particularly strong against the European majors, the euro and the pound.
Asian currencies have also tumbled, particularly the Korean won followed by the Indian rupee. In case of India, the offshore non-deliverable market action has been leading the local onshore market action.
The NDF market allows participants not allowed in the onshore market to hedge currency risk or place bets on non-convertible currencies such as the Indian rupee.
Last week, the rupee-dollar pair continued to trade at much higher levels in the NDF market at various tenors, prompting local market participants to go long on the greenback.
The RBI has been supporting the rupee by selling dollars. The central bank has sold a net of $7.1 billion between April and July. During June and July, the RBI also conducted special market operations with oil marketing companies and met their dollar demand directly and sold them $5.3 billion. In the month of August, the foreign exchange reserves declined by over $10 billion and in the first week of September, they fell by another $6.5 billion. This suggests that the RBI has been very active in its efforts to support the rupee. The central bank, however, is only trying to arrest the pace of its depreciation.
The RBI's spot market intervention is, to some extent, being neutralised by its actions in the forward market. The central bank, in order to reverse its outstanding forward dollar purchases, has been doing swap transactions. These involve buying dollars in the spot and selling them back in the forward market in various maturities to offset its outstanding purchases in those maturities. This creates pressure on the spot rupee, as these swap transactions flush out the dollars sold earlier by the RBI. That, in turn, exacerbates the pressure on the spot rupee and eases the forward premiums.
Such forward market intervention also helps return to the banking system rupee liquidity that was initially taken out by the RBI dollar sales. In a nutshell, as long as the RBI continues with its buy/sell swap transactions, its spot market intervention to support the rupee will not be very effective.
Given that the RBI has two considerations for such actions -- reversing its long forward positions and keeping the rupee liquidity from squeezing too much -- the central bank can carry on with the buy/sell transactions for at least till the end of this month.
The outstanding long forward dollar positions of the RBI in all tenors up to one year was an estimated $10 billion at the end of August. Through its aggressive buy/sell swaps over the last couple of weeks, the central bank has ensured that it has reversed most of these positions. However, the RBI might continue to do buy/sell swaps over the next couple of weeks to support the rupee liquidity. On September 15, the second instalment of advance taxes will flow out of the banking system. That amount is estimated to be about Rs 55,000 crore. This will put severe pressure on the liquidity in the banking system and exert upward pressure on overnight call money rate. To prevent that from happening, the RBI could continue to supply rupee liquidity through its buy/sell transactions. It would also continue supporting the rupee through its spot market dollar sales.
The rupee could also receive support from an improvement in supply of dollars from exporters and from the continuing decline in the prices of crude oil. The movements in the US dollar overseas will be more important though.
This week is particularly important for the greenback, as it would see the US Federal Reserve announcing its rate decision on Tuesday. There is little chance that the Fed is going to shift the benchmark from its steady 2%. Fed Fund futures show a modest 12% probability of a 0.25% rate cut on Tuesday.
As the end of the year approaches, the odds go up. There is a 23% chance of a cut on October 29 and 31% probability of one on December 16. While the majority of the market is still against a revived rate easing cycle, it is a clear departure from the near certainty of at least one 0.25% rate hike forecasted only a few months ago that had initially triggered the dollar's rally.
Economic trends and recent Fed commentary certainly support the dovish outlook. In the past month, employment and consumer spending contracted, the housing recession continued, inflation cooled and financial markets fell further off kilter. Should the Fed comment on easing inflation, fading growth prospects and persistent financial market disorder, the greenback will certainly be under pressure.
The rupee-dollar pair could therefore continue to approach the 46 mark over Monday and Tuesday. Depending on the Fed policy statement's tone, which could be dovish, the rupee could gain some ground. Overall the rupee-dollar pair could trade in the range of 45.20-46.00 compared with a much wider range of 44.11-45.785 last week.
(The author is senior economist, ABN Amro Bank. Views expressed herein are personal.
E-mail: gaurav.kapur
@in.abnamro.com)
