Rupee rise to continue on global risk appetite

Financial markets extended their rally last week on sustained risk appetite. Confidence-boosting hopes of a global economic recovery grew stronger on robust figures for manufacturing and services PMIs (purchasing managers’ index) from major global economies, including India where services grew at their fastest in six months. So, the ongoing rally in riskier assets led by the global equities market received further impetus. The FTSE All-World stock index rose 1%, reaching its best levels since August.

In the currency market, the dollar strengthened last Friday after US data showed a larger-than-expected rise in new jobs in January. The greenback rose against the euro, the pound and the yen as the market felt that chances of a fresh US Fed quantitative easing were slim. The dollar, however, fell against commodity and emerging market currencies as the market interpreted US data as positive for global growth.

The yen hit its strongest level last week since the Bank of Japan last intervened in October, reaching ¥76.00 to the dollar. On Friday, however, the dollar rose 0.4% against the yen, erasing the gains made by the Japanese currency over the course of the week.

Other Asian currencies rose for a fifth week. The Rupee continued to gain against the dollar helped by a strong global investor risk appetite which saw Indian equities and bonds attracting greater capital inflows. The rupee-dollar pair moved past the 49.00 mark for the first time since October 2011.

The pair traded in the range of 48.6700-49.8213 and rupee appreciated 1.3% over the week.

Looking ahead, there is no doubt the dollar is weakening. In about three weeks, the Dow Jones FXCM Dollar Index has dropped nearly 3.6% - a significant change from the start of the year, when this benchmark for dollar-strength was looking to move on 12-month highs.

We have seen the Dow Jones Industrial Average lead a powerful rise in risk appetite that saw the index itself rising close to a four-year high. And, if risk appetite sustains, there is little to prevent the safe haven, low-yield dollar  from faltering further.

The strength of risk appetite is, however, not assured and can reverse quickly on any euro zone negative news. For example, in the absence of a debt deal and additional bailout funds, Greece could end up defaulting on its debt maturing over the next couple of months.

Markets have not priced this in considering the recent rally. The exceptionally bullish US jobs data has overshadowed the breakdown of talks between Greece and its private lenders. Some degree of risk aversion is to be expected. A default by Greece can easily choke the sovereign funding for other debt-burdened countries like Italy and Spain, and raise concerns over global growth afresh.

In India, the momentum would continue to favour the rupee, as long as global risk appetite remains strong and foreign institutional investors keep pouring money into India. Given that the risk rally has, however, continued unabated so far this year, some correction in risk assets could happen, particularly as markets take note of the situation around the Greece debt-swap deal.

That would affect Indian market sentiment and arrest the rupee’s appreciation.

Moreover, the Reserve Bank of India (RBI) would also be looking to reduce the size of its intervention in the foreign exchange market, given the very tight rupee liquidity conditions in the inter-bank market.

Hence, any further upside on the rupee may now be muted after five
successive weeks of gains against the dollar. Over this week, the rupee-dollar pair
could trade in the range of 48.25-49.50.

The writer is senior economist, Royal Bank of Scotland NV, and can be reached at gaurav.kapur@rbs.com
Views are personal.