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Last week was a reminder of the fact thatthe Indian economy is increasingly getting integrated with the global economy.

The rupee plunged sharply to levels seen in April last year against the US dollar as global economic conditions turned more adverse. Of particular concern was an over 8% jump in the crude oil prices to a new all time high.

That, along with the continued strengthening of the US dollar against Asian currencies, led the Indian unit to lose 2.3% of its value against the greenback over the week.

Large demand for dollars by oil companies and other importers along with muted capital inflows sent the rupee crashing sharply. Market participants, noting the mounting pressure on India’s trade deficit from spiralling oil and other commodity prices, turned increasingly bearish on the rupee.

Moreover, in the offshore non-deliverable forwards market, bets against the Asian currencies and in favour of the greenback, negatively affected currencies of many region. As a result, besides the Indian rupee, the Korean won also slid sharply over last week. A slide in the local equities market also adversely affected the market sentiment.

While the rupee fell, the Reserve Bank of India was not seen in the market to protect it in a determined fashion. Considering that a weaker rupee adds to inflationary pressures from rising international commodity prices, market participants were expecting some counter action by the central bank. However, the RBI chose not to intervene to protect a particular level.

The central bank’s actions need to be seen in the light of the growing size of the local foreign currency market, which now has an annual turnover of over $6 trillion. Thus, any attempt to arrest rupee’s slide would involve large-scale dollar selling and could lead to more speculative action in the pair. Having said that, the RBI has an extant policy of curbing excessive volatility in the rupee-dollar pair.

Last week’s fall in the rupee would certainly have caused the central bank to take notice. Therefore, even though, worsening external fundamentals is driving the rupee lower, RBI would step in at some stage. RBI’s support to the rupee would, however, aim to break its fall than protect any particular level.

Over the last week, after trailing sharply for the first four days, the rupee
recovered some ground on Friday. Market participants unwound their long dollar
positions and even some large inflows hit the market. Over the week, the rupee-dollar pair traded in the range of 40.52-41.795.

This week, the movements in the rupee-dollar pair could remain restrained compared to the last week. The pair could trade in the range of 41.20-41.80 with a bias for a weaker rupee.

The main risk to this scenario remains from the rising prices of crude oil. Opec has already indicated that crude oil could touch $200 a barrel in the near future with an intermediate level of $150 in the near term. Under such pressures, the country’s trade deficit will widen further. And, if capital inflows do not pick up, the first quarter of the current fiscal year could even end up with a balance of payments deficit. The greenback’s free fall has also been arrested and it is likely to remain stable in the near term.

In the overseas market this week, the focus will be on the US data releases. Retail sales data, the key indicator of consumer spending in the US economy is due.

Considering the upside surprises to recent data points, particularly non-farm payrolls, and given the strong earnings of retailers like Wal-Mart, retail sales may not be as bad as the market expects. The impact of a strong reading on the greenback would be limited though considering that the market has already discounted a pause by the Fed in June.

In the international price action last week, the euro dropped to a two-month low against the US dollar, as the perception that the single currency might have peaked gripped the market. The euro plunged to a low of $1.5287 on Thursday. The euro’s slide was caused by continued weakness in eurozone economic data, which heightened expectations that the European Central Bank might shy away from its hawkish stance on interest rates and signal that it was ready to start cutting interest rates.

The single currency recovered later on Thursday after the ECB president stuck to his guns and reiterated concerns over rising price pressures. The ECB kept interest rates on hold at 4% after its monthly policy meeting. The euro rose 0.4% over the week against the greenback.

Pound, the other European major, dropped to a 10-week low against the US dollar as more evidence emerged of UK economy suffering from the effects of the turbulence on financial markets. Although the pound staged a small recovery after the Bank of England kept interest rates unchanged on Thursday, market participants are expecting the BoE to resume its monetary easing cycle in June. Over the week, the pound fell 0.9% to the US dollar, lost 1.3% against the euro and fell 3.3% against the yen.

The yen advanced as increased turbulence in global equities heightened risk aversion, boosting demand for the safe haven of the low-yielding Japanese currency. The yen rose 2.4% against the greenback over the week.

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