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The Indian economy has been operating under a number of uncertainties since October last year.

The current global economic turmoil along with the elections had made it very difficult for the market participants, foreign investors, corporate sector and even consumers to decide their future course of action, thereby affecting economic activity severely.

Over the last one month, as the country went into elections, the political uncertainty was all pervasive. With consensus view of a hung parliament and a fractured government, the room for optimism was limited even though improving domestic economic conditions and stabilising global economy provided some reason to cheer.

In this backdrop, a decisive mandate to the Congress-led UPA to run the government for the next five years has come as a major positive surprise. This outcome promises to provide a stable government at the Centre, which is very critical for managing the economy through this period of immense global turbulence and undertake the much needed reforms to support the economy in the long run. Moreover, continuity in the overall policy framework is also crucial.

This week, therefore, promises to start on a positive note for the local equities and the rupee. The signs of improvement on the external front in the form of a pick-up in portfolio flows and narrowing of the merchandise trade deficit along with the global equity market rally have already created supportive conditions for the Indian unit.

For instance, the FIIs have been net buyers of Indian equities and bonds since the start of this fiscal year in April. Even last week their net purchases amounted to $948.3 million. A stable government at the Centre would further bolster the appetite of the FIIs for local equities and improve the inflow of capital into India.

While the domestic developments in the previous week will have a favourable impact on the rupee and the local stock market, the global markets scenario could prove to be a dampener of sorts. Last week, market participants questioned the basis for the improvement in risk appetite seen over last month.

Economic data released over the week triggered a reassessment of the rise in investor confidence. Chinese industrial production and US retail sales were both weaker than expected and there was a sharp slump in German GDP for the first quarter of 2009. Renewed doubts over prospects for a rapid recovery in the global economy caused risk appetite to weaken, dragging equity markets lower.

In the currency market, the Japanese yen advanced and the US dollar consolidated after recent losses. Both currencies have come under pressure in the past month as equity markets rallied on hopes that the worst of the global downturn was over. Over the week, the US dollar rose 1.1% against euro, gained 0.5% against pound and was 1.4% up against the Swiss franc. The greenback fared better against commodity-linked currencies. It rose 2.7% against the Australian dollar, climbed 1.6% against the Canadian dollar and gained 2.3% against the New Zealand dollar.

The yen put in a stronger performance and rose 3.4% against the US dollar over the week. The main force behind the yen’s strength was the tightening of yield differentials between US and Japanese government bonds. As the yield spread between US 10-year treasuries and Japanese government bonds dropped from a peak of 193 basis points at the end of last week to 167 basis points on Friday, the yen advanced.

Moreover, data released from Japan revealed that investment flows had turned favourable for the yen in April. Heavy buying of foreign securities by Japanese investors had dried up during that month. After average net purchases of foreign bonds and equities of yen 2,829 billion per month in the first quarter of 2009, Japanese investors bought just yen 502 billion in April.

And, net foreign purchases of Japanese equities turned positive for the first time since June 2008. Over the week, the yen rose 4.5% against the euro, climbed 6.1% against Australian dollar and gained 3.9% against pound.

Meanwhile, pound rose to a four-month high against the US dollar on Tuesday after the better-than-expected manufacturing and retail sales figures raised hopes that the UK economy was reaching the bottom of the recession.

But the pound was undermined after Bank of England delivered a downbeat assessment on Wednesday of the UK economy being “vulnerable to further shocks”. Over the week, pound rose 0.6% against the euro.

This week, the economic calendar in the US is light with no major data releases due. Recent improvements in data have put market participants on the watch for “green shoots”. We will see whether the US Federal Reserve sees the same signs of hope with the minutes from the Federal Open Market Committee’s (FOMC) last policy meeting over April 28-29 due for release. In previous statements, the FOMC has maintained its forecast for a contraction through the rest of this year and a slow recovery through the first half of 2010.

If the FOMC is more encouraged by recent data and it projects a recovery sometime before the turn of the year, it would be an indication of the US economy outpacing Japan, the UK and perhaps even the Eurozone. That could boost the waning risk appetite.

In the local market, a relief rally for the rupee looks quiet certain this week. It could only be tempered if the global equity market conditions worsen significantly and act as drag on the local stock market. Otherwise markets would not worry yet about the possibility of a sovereign ratings downgrade, given that the initiatives announced by the Congress in its manifesto are likely to strain the fiscal situation even more. The rupee-dollar pair could trade in the range of 48.50-49.25 on the back of a clear electoral mandate.