Column

Gaurav Kapur
Senior economist,
ABN Amro Bank

Bearishness towards the US dollar prevailed last week in the market. The greenback has been under pressure since the Federal Reserve surprised the market with a 0.50% cut in the overnight Fed funds rate on September 18.

Weak US data releases last week, including a plunge in house sales to their lowest in nearly a decade and a drop in consumer confidence to a two-year trough, heightened expectations that the Fed would cut interest rates further in the coming months.

The US dollar plunged more on these expectations. Last week, the trade-weighted dollar index, which tracks greenback’s value against a basket of six leading currencies, dropped to its weakest level since the Fed launched the data series in 1973.

During the week, the greenback fell to a series of fresh record lows against the euro.

Depreciation of 1.3% took its losses against the single currency to 6% over the quarter. The euro was also supported by the data for consumer price inflation in the Euro-zone, which rose by 2.1% in September.

That was the highest rate in more than a year and above the European Central Bank’s 2% target.

The Fed’s rate cut has also helped to improve the risk appetite among investors and alleviate the liquidity crunch in the money markets.

As a result, riskier assets classes, particularly equities have gained sharply. Indian equity market has also benefited from this and the BSE-Sensex has seen its fastest 1000 point rally from 16,000 to 17,000.

And, this has driven by some heavy buying by the FIIs. Their net purchases have amounted to $3.3 billion in the last fortnight, of which $2 billion were made last week.

In the face of plunging US dollar and the deluge of capital inflows over the past two weeks, the rupee has been under strong appreciation pressure.

That has once again forced the RBI to intervene heavily in the currency market, in order to arrest rupee’s gains.

The extent of RBI’s dollar buying is reflected in the $3.7 billion increase in its foreign exchange reserves during the week ended September 21.

Besides direct market intervention, the RBI also liberalised overseas investment norms for Indian companies and mutual funds, raised the prepayment limit for external commercial borrowings and doubled the foreign remittance limit for individuals last week.

This was done to counter balance the rising capital inflows with capital outflows, which in turn would be helpful to control rupee’s rise against the greenback.

These measures, however, had a little impact on the value of the rupee last week, as capital inflows continued at a vigorous pace.

Central bank intervention and dollar buying by the oil companies countered the appreciation pressure on the rupee. The rupee-dollar pair finished the week almost flat after moving in a range of 39.61 - 39.90 over the week.

The rupee, however, depreciated against the European majors and the Japanese yen. Over the week, the Indian unit lost 1.3% each against the euro and the pound sterling and 0.53% against the yen, as all these currencies appreciated against the US dollar.

Premiums in the rupee-dollar forwards market also eased across all tenors, as exporters hedged their dollar exposure by booking forward contracts. One-month premium dropped the most, by 0.62% over the week, suggesting that most of the hedging activity took place in shorter tenors.

India’s balance of payments statistics for the first quarter of FY 2007-08, which were released on Friday just highlighted the fact that capital inflows remain much in excess of the current account deficit.

This is likely to be scenario for the rest of the fiscal year too, even though the current account deficit would be larger this year, given the rapid rise in oil prices and a slowdown in exports. That in turn would continue to drive rupee’s appreciation.

This week too, rupee would continue to face appreciation pressures. With risk appetites improving and equities gaining on the back of that, local stock market conditions would support a stronger rupee.

However, the sheer pace at which the benchmark BSE Sensex has climbed, the risk of correction remains in the background.

Moreover the RBI has shown strong resolve to keep a lid on the rupee’s strength. The central bank would continue to buy dollars and manage the resultant injection of rupee liquidity through open market bond sales.

With headline inflation now at a 5-year low, the central bank can focus on maintaining exports competitiveness. High oil prices would also help in arresting rupee’s gains.

It seems that the rupee-dollar pair would continue to trade in a narrow range of 39.60 - 40.00 this week. The main risk to this scenario lies in the US non-farm payrolls data, due this Friday, significantly over-shooting market expectations of job growth of 100,000 in September.

If that does happen, the greenback could see some correction. Every data release before it, including manufacturing and service sector ISM survey data, will be used to help forecast whether payrolls will be weak or strong. Thus US data releases would be important this week.

The author is senior economist, ABN Amro Bank.
Views expressed herein are personal.
E-mail: gaurav.kapur@in.abnamro.com