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ShareThough US may see rate cuts, RBI, however, may not wield the axe
After the market upheaval following the proposed guidelines on restricting inflows through the participatory note route, things were limped back to normalcy by the end of last week.
Under the final guidelines, Sebi allowed sub-accounts of FIIs to also register as FII and gave long-term investors, such as pension funds, the option to register as FII.
The capital market regulator, however, made it difficult for some hedge funds to buy local stocks as under the final guidelines, only regulated entities have been allowed to register as FII.
Therefore, unregulated hedge funds have been kept out of the market. Sebi also cleared the applications of 16 entities seeking FII status.
Stock market participants were relieved by the final guidelines, particularly the clarification on sub-accounts.
Over the week, BSE-Sensex rallied by about 10%, closing the week at a new high. Rally in global equity markets also buoyed local sentiments.
Rupee also followed the equities market and appreciated by about 0.8% over the week against the greenback.
The rupee-dollar pair traded in the wide range of 39.435-39.92 last week. At the start of the week, the Indian unit was pulled down by the FIIs withdrawing their funds from local assets.
Net sales by FIIs last week amounted to $368.3 million, with last Monday witnessing the largest net sales of $797 million.
However, exporters continued to offload dollars and even FIIs turned net buyersin the second half of the week.
Banks remained short on greenback, noting its weakness in the overseas market and the market rally. Intervention by the RBI kept rupee gains under the check.
This week two crucial events are due. The RBI will hold its half-yearly review of the annual monetary policy on October 30.
The monetary policy committee of the US Federal Reserve will announce its rate decision the next day.
The outcome of these events will have a significant impact on the markets . The Indian central bank is expected to keep its policy rates unchanged, as headline WPI inflation has eased sharply and is much within its comfort rate of 5%.
That would be beneficial for rupee, as such a move would not only boost the confidence in the equity market, it would also keep the interest rate advantage intact.
There is a limited possibility that the cash reserve ratio (CRR) might be hiked in order to keep the overall money supply growth in check.
Growth in money supply has accelerated due to heavy intervention by the RBI in the currency market and the improvement in bank credit offtake over last few months.
Latest data shows that broad money supply is growing at an annualised rate of 21.8%, much higher than the RBI target of 17-17.5% for this fiscal year.
Presence of strong inflationary pressures, particularly from the commodity prices and the consumer price inflation still holding well above 6%, precludes the possibility of any cut in rates.
There is some market speculation, however, that the repo rate of 7.75% could be reduced by 25 bps. That might not have any material impact on the market rates in general.
Given the excess liquidity in the banking system, the operational short-term rate is the reverse repo rate of 6%. The repo rate only becomes an anchor rate for the market when there is a shortage of liquidity.
In case the CRR is raised, equity market could be negatively impacted, in which case the rupee will come under some pressure. Otherwise, on a standalone basis, a CRR hike helps the rupee.
However, the negative impact of any possible monetary policy tightening by the RBI would be countered by a likely Fed rate cut this week.
Fed funds futures have fully priced in a 25 bps cut in the overnight funds rate with some chances of even a 50 bps cut. The Fed is likely to maintain a cautious stance on growth as risks of a prolonged slowdown in the US economy are rising.
Last week, data showed signs of worsening conditions in the US housing market. At the same time, the Fed cannot ignore the risks building up on the inflation front, with the greenback weakening to a record low and oil prices soaring to a record high.
The policy statement will, therefore, be critical in understanding the Fed stance on rates. Futures markets continue to price in multiple rate cuts, all the way into 2008.
Easing of monetary levers in the world's largest economy will only fan the appetite of global investors for riskier assets and weaken the US dollar further.
However, with chances of credit market troubles coming to forefront again and crude oil prices approaching $100 per barrel mark, investors could turn a little cautious.
Local market participants will have to brace themselves for another week of volatility. Lot depends on the outcome of the two key events.
The scale is clearly tipped towards further appreciation of the rupee, but rising crude oil prices is a clear and present danger.
Overall the rupee-dollar pair could trade in 39.30-39.80 range.
