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Thus, even as the greenback strengthened, it underperformed the Japanese yen on the back of unwinding of carry trades. Continued deterioration in Euro-zone and UK data kept the euro and the pound under pressure.
The European Central Bank, which kept rates on hold at 4.25% after its policy meeting, revised down its growth projections for the region. The dollar rose 2.8% to an 11-month high against the euro over the week.
The pound came under pressure as the Bank of England, which kept rates on hold at 5% after its meeting, revealed that UK mortgage approvals hit a record low in July. This increased concerns that the UK’s fragile housing market would lead the economy into recession. The pound fell 3% against the greenback on the week, hitting its weakest level since April 2006.
The Australian dollar was the worst hit, tumbling 4.9% to a one-year low against the greenback and sliding 5.8% against the yen, as commodity prices eased. The Aussie dollar was also undermined as the Reserve Bank of Australia cut interest rates for the first time in seven years, lowering its main lending rate 0.25% to 7%. The greenback also rose 1.6% against the Swiss franc on the week. But the US dollar lost ground against the yen, falling 1% over the week, as falling asset prices heightened risk aversion. This drove investors away from carry trades.
The US dollar strength exerted heavy downward pressure on the Asian currencies too. The Indian rupee also saw another week of deterioration in value. After depreciating by 3.2% in August, the Indian unit lost another 1.6% against the US dollar last week. The rupee slid sharply on pressure from the offshore non-deliverable forwards (NDF) market.
An onshore-offshore arbitrage emerged at the start of the week itself, as the greenback’s strength pushed the rupee lower in the offshore forwards market compared with the onshore market. Market participants taking a cue from that built up long dollar positions even as a shortage for cash dollars persisted in the market.
The RBI intervened to support the rupee at various levels over the week thus helping arrest its free fall. However, the central bank’s actions besides its dollar sales in the spot market also exerted some pressure on the rupee. While the RBI sold dollars in the spot, it continued with buy/sell swaps, under which it buys dollars in spot market and sells them back in forward market.
Thus, while its spot market sale of dollars helped arrest rupee depreciation, the buy leg of the swap transaction put pressure on the rupee again.
Such actions by the central bank seem to be motivated by its need to reverse its forward dollar purchases and at the same time ensure that its market intervention is rupee liquidity neutral. As of July 31, the RBI had outstanding forward dollar purchases worth $11.9 billion. Of that, $5.8 billion is outstanding in tenors up to three months.
These forward purchases were made at a time when capital inflows were robust and the RBI instead of absorbing most of these flows from the spot market bought a portion through the forwards market. But now with the rupee requiring support and with capital inflows having dried up, the central bank is reversing its forward purchases through the buy/sell swap transactions.
The RBI, it seems, is also ensuring that rupee liquidity drained through its dollar purchases is returned back to the system. To meet both objectives, the size of the buy leg of swap transaction would tend to be larger than the amount of dollars sold in the spot market. That adds to the downward pressure on the rupee.
Aside from these technical factors affecting the rupee, the external fundamentals also remain unfavourable for the Indian currency. The latest merchandise trade data released last week showed that the trade deficit widened to $41.2 billion during April-July 2008.
That is 51% higher than the deficit of $27.4 billion over the same period last year. On the positive side, exports are growing at a brisk pace and recorded 24.6% growth during this period. With oil and other commodity prices having eased, the trade situation could improve going forward. Last week, crude oil prices fell by another 7.6%, taking its cumulative decline to 26.7%, from an all-time high of $145.3/bbl touched in early July. Over the week, the rupee-dollar pair traded in the 44.05-44.735 range. In the forwards market, premia for buying forward dollars eased across tenors as the rupee depreciated sharply over the week.
This week, the US dollar is susceptible to a substantial event risk. The greatest threat to the greenback is the fate of Fannie Mae and Freddie Mac. Shares of these two government-sponsored mortgage giants plummeted after Friday’s stock market close amid speculation that the US Treasury will announce plans to inject capital over the weekend.
If this is indeed the case, the news could trigger another bout of flight-to-safety, sending US Treasuries higher and the US dollar, stocks lower, and the yen higher (like the Bear Stearns announcement on March 16).
A slide in the US dollar could give some respite to the beleaguered rupee. Even otherwise, the rapid pace of its depreciation over the last few weeks suggests that it could hold ground around current levels for some time. A sharp decline in oil prices too would prove helpful for the Indian unit. However, in case of global risk aversion, the local equity market would come under pressure and could see a sell-off by foreign institutional investors. Also, if the RBI continues with its buy/sell swaps, the rupee could remain under pressure. Overall the rupee-dollar pair could trade in the range of 44.40-45.00 this week.
(The author is senior economist, ABN Amro Bank. Views expressed herein are personal. E-mail: gaurav.kapur@in.abnamro.com)