Column

Global financial markets witnessed another difficult week. Confidence of investors and other market participants was eroded further due to evidence of a worsening recession, further negative news from the financial sector and mounting scepticism about the response of policymakers to the financial crisis. The latest policy moves by G10 central banks, including aggressive interest rate cuts by the European Central Bank (ECB) and the Bank of Canada, and the Bank of England’s shift to quantitative easing did little to restore flagging confidence. Risk aversion prevailed with market participants choosing safety of US treasuries and the dollar.

The greenback rose to a three-year high as renewed weakness on equity markets and more evidence of a sharp slowdown in the global economy drove investors to the haven of the US dollar. The dollar index, which tracks its progress against a trade weighted basket of six major currencies, rose to its strongest level since April 2006 on Wednesday. Besides the greenback’s safe-haven role, its status as the dominant reserve and funding currency were important features supporting it. One of the primary sources of support for the dollar since September last year has been the increased pressure on
European banks to cover dollar funding gaps.

This form of demand is likely to remain in play while banks continue to de-leverage and shrink their balance sheets. After hitting a four-month high against the euro on Wednesday and against the Japanese yen on Thursday, the greenback retreated on Friday, as data showed the US unemployment rate rose to 8.1% in February, its highest level in 25 years. Over the week, the US dollar gained 0.2% against the euro, lost 0.9% against the Swiss franc and gained 0.9% against the yen.

The euro fell on Thursday after the ECB cut Eurozone interest rates by 0.5% to 1.5% and Jean-Claude Trichet, president of the ECB, struck a dovish tone, warning that the region faced a sharp slowdown and inflationary pressures had eased. The euro recovered on Friday to finish 0.7% stronger against the yen on the week, but lost 1.1% against the Swiss franc.

The other European major, the pound, lost ground as the Bank of England cut interest rates by 50 basis points (bps) to a record low of 0.5% and revealed details of its plans to initiate quantitative easing to boost the British economy.Over the week, the pound fell 1.4% against the euro and lost 1.6% against the dollar.

Meanwhile, the Swedish krona fell to a fresh record low against the euro as fears over the extent of Swedish banks’ exposure to problems in the Baltic states intensified. The krona dropped 2% to against the euro on the week and fell 1.7% against the greenback.

In the local inter-bank market, the rupee fell to a new low, as a stronger US dollar overseas, sliding equity markets and continuing exodus of the FII funds, pushed the rupee-dollar pair past the 52 mark in intra-day trading. The BSE Sensex fell by 6.4% over the week, as FIIs sold $646 million worth of stocks and bonds.

The RBI supported the rupee through its market intervention and with the announcement that it will resume special market operations (SMO) for oil companies. Under the SMO window, the RBI sells dollars to oil companies and provides funds to them by buying their oil bonds. The news of resumption of SMO helped the rupee. The central bank also went ahead with another rate cut of 0.5%, which did not cheer the equity market and hence proved of little support to the Indian unit.

Merchandise trade data released over the week showed that exports registered negative y-o-y growth for the fourth consecutive month in January and media reports suggest that this trend continued in February as well. While imports also registered negative growth in January on the back of lower oil prices, trade data just underlines the fact the external fundamentals remain weak.

The rupee depreciated by 1.1% against the greenback last week and the rupee-dollar pair traded in the range of 51.40-52.17.

This week, rupee would continue to get support from the resumption of the SMO by the RBI with oil companies, as that reduces the dollar demand from the market. That could keep the rupee from falling past its new all-time low mark of 52.17 for some time. On the other hand, global economic and market conditions remain unfavourable for the Indian unit over the next quarter at least. De-leveraging by investors would continue to put pressure on the local stocks market and therefore, the rupee.

The possibility of a collapse of some East European economies and the overall sentiment of risk aversion would keep emerging markets out of favour. No major shift is likely to occur in the risk perceptions in the near future. Therefore, the rupee remains vulnerable, as most other Asian currencies, to the US dollar’s safe-haven status, and is poised to remain weak for some more time.The rupee-dollar pair could trade in the range of 51.50-52.15 this week.

For the US dollar itself, the commerce department is forecasted to report that US retail sales fell in February for the seventh time in the past eight months, as deteriorating labour markets, tight credit conditions, and a year-long recession weigh heavy on the minds of consumers.

More specifically, retail sales are anticipated to have contracted 0.5% during the month, and excluding auto sales are expected to have slumped 0.2%, marking what may end up being a trend through the first half of 2009. As we saw withUS non-farm payrolls data last week, the impact of a disappointing result may be mixed, as the Federal Reserve has already cut the Fed funds target to a record low range of 0%-0.25% and has no room to cut further.

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