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The Indian rupee’s appreciation has lasted for as many as three successive weeks on
the back of favourable conditions. Adding to its gains of the previous fortnight, the rupee rose by about 1.2% against the US dollar last week, helped by a 4.9% drop in oil prices and a stock market rally.

Crude oil prices softened for the second consecutive week, taking the total decline to 15% in the last fortnight. That has been a significant positive development for the rupee. Declining oil prices reduce the pressure exerted on local unit through a large and growing oil imports bill.

Another favourable development came in the form of a rally in the equities market, which also extended into the second straight week. The BSE Sensex gained 4.7% over the week, boosted by the UPA government comfortably winning the trust vote. That was seen by the market participants as a positive development given the possibility that the government will now kickstart its stalled economic reforms process.

That would help improve the likelihood of achieving higher economic growth on a sustainable basis. Even foreign institutional investors (FIIs) showed renewed confidence and purchased a net amount of $585.3 million of local assets last week.

At lower levels of the rupee-dollar pair, importers took the opportunity to buy dollars. Oil companies were also back in the market. Since May 29, the RBI had been meeting their dollar demands directly through its special market operations. Oil marketing companies were raising rupee funds from the central bank by selling their stock of oil bonds and using the proceeds to buy dollars from the RBI. However, these companies have run out of oil bonds and they are therefore again buying dollars from the inter-bank market.

Dollar demand from importers, along with a decline in the stock market towards the end of the week, put a lid on the rupee gains.

Over the week, the rupee-dollar pair traded in a wide range of 41.81-42.84. The Indian unit appreciated not only against the greenback, but also against other major currencies. As the US dollar strengthened against these currencies last week, rupee gained much more against them. As a result, on July 25, the rupee was overvalued by almost 4% against a trade weighted inflation adjusted basket of six currencies.

In the overseas market, the US dollar trounced other major currencies last week. The greenback rallied across the board as US authorities tried to soothe concerns over the health of the US financial system. Hank Paulson, US Treasury secretary, reiterated on Tuesday that a strong dollar was “very” important to that country’s interests. He reassured investors that the US government was moving ahead with plans to resolve the mortgage crisis. These comments helped support financial stocks and lift the greenback. However, a wobble in US bank shares later in the week took some of the shine off the greenback’s advance.

The euro slid 0.9% against the greenback over the week. The dollar also rose 0.8% to against the yen, climbed 1.3% against the Swiss franc and gained 1.5% against the Australian dollar.

The dollar’s advance was less marked against the pound, rising 0.4% in the week, after the minutes of the Bank of England’s July monetary policy committee struck a more hawkish tone than expected. The minutes revealed that one of the nine members of the committee voted to raise interest rates to fight inflation. The news surprised investors who were expecting the only dissent to the decision to keep rates on hold at 5% would be a vote for a cut. The pound climbed 0.5% against the euro over the week and rose 0.4% against the yen.

This week local market participants will keenly follow the quarterly review of the monetary and credit policy by the RBI, due on Tuesday. With inflation remaining the main concern for the Indian central bank, some more monetary tightening steps can be expected.

A repo rate hike by 25 bps at least looks the most likely scenario. That should be helpful for the rupee. Otherwise market participants would also look for RBI guidance on growth prospects this year and its inflation outlook. The RBI has set a growth target of 8-8.5% and inflation target of 5.5% by the end of the year.

With serious risks to growth and strong inflationary pressures persisting, the central bank is likely to downgrade its growth forecast and set itself a more realistic inflation target.

Macro-economic data releases from the US will take the centrestage mid-week onwards. Key data points are due for release including the second quarter GDP, non-farm payrolls and manufacturing ISM index for July. While last week’s strong data releases helped the greenback strengthen, these data points could bring to the fore fears of a prolonged slowdown in the US economy and thus undermine the US dollar. The payrolls report could be particularly negative, as there has been no end to layoff announcements and job losses could be far worse than the market’s forecast of -75,000.

A weaker US dollar could boost oil prices, but more negative news from the US economy on the growth front would act as a dampener for a sharp rise in prices. Thus even this week, oil prices could remain subdued. That, along with the possibility of a rate hike by the RBI, could help the rupee. The rupee-dollar pair could trade in the range of 41.75-42.50.

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